2024 Colorado 1031 Exchange Guide
If you are planning to sell an investment property in Colorado, you may be able to use a 1031 exchange to defer the capital gains taxes that would normally be incurred by such a sale. There are several rules that must be met, but a successful 1031 exchange can provide many benefits for you as an investor.
What is a 1031 Exchange?
A 1031 exchange is an IRS-approved transaction in which you as a real estate investor can sell one or more of your properties and defer the capital gains taxes on the sale amount, so long as you immediately reinvest the proceeds in the purchase of one or more like-kind properties and follow all the rules of a 1031 exchange.
Benefits of a Colorado 1031 Exchange
There are many benefits of 1031 exchanges. The biggest and most obvious one is that you will not immediately have to pay capital gains taxes on the proceeds of the property that you sold, which means you can leverage more equity to purchase a more valuable replacement property. In this way, you can increase your income by trading up to a property that produces more income, and you can also alleviate maintenance burdens by swapping a high maintenance property for lower maintenance or managed property.
Since it’s much easier to acquire a variety of properties using 1031 exchanges, you can diversify your portfolio and decrease risk by investing in a wide variety of property types. You can also select property types that allow you to take maximum advantage of depreciation benefits.
Finally, 1031 exchanges can be a valuable estate planning tool. While they are technically tax-deferred exchanges, you can acquire a property through a 1031 exchange, leave it in your will to an heir, when you die and the heir takes possession of the property, the value will be stepped up to fair market value and your heir will not have to pay any capital gains taxes on the property. You can also use a 1031 exchange to trade one large property for three smaller properties if you want to leave one to each of your three children, or swap for properties that your heirs will be interested in.
1031 Exchange Myths
Although 1031 exchanges have been allowed in the United States since 1921, there are still a lot of myths and misconceptions about them.
Myth: 1031 Exchanges Are Only For The Wealthy
This is simply not true, but the impression exists because only high-profile 1031 exchanges between big corporations or famous individuals tend to make the headlines. Everyday people can and do use 1031 exchanges on a regular basis as a way to grow their wealth, diversify their investments, and move investments around the country. As we’ll cover in the rules section later in this article, almost any kind of investment or business property can be traded for any other kind with a 1031 exchange.
Myth: A 1031 Exchange Must Be Simultaneous
Under the original 1031 exchange rules, exchanges had to happen simultaneously. However, this expanded over time to allow for greater flexibility. Now, the original simultaneous exchange still exists, as well as three types of exchanges that happen over the course of 180 days: the delayed exchange, a reverse exchange, and a construction or improvement exchange.
1031 Exchange Rules
Here are some of the main rules for delayed 1031 exchanges, which are by far the most popular.
Qualifying, Like-Kind Properties
Properties must be held for business or investment purposes, and all properties involved in an exchange must be like-kind. This means that they must be similar in nature, although many different types of businesses qualify, including single-family rental homes, apartment complexes, commercial properties, restaurant rentals, and undeveloped land.
The entire sale amount of the relinquished property must go towards the purchase of the replacement property or properties in order to completely defer the capital gains taxes. However, you can still complete an exchange if the replacement property costs less than the relinquished property, but you will have to pay capital gains taxes on the difference, which is called the ‘boot.’
With a delayed 1031 exchange, you have 45 days from the date of sale of your relinquished property to officially identify potential replacement properties. You have 180 days from the date of sale to purchase a replacement property. Failure to meet the timeline rules or any other rules will result in the disqualification of your 1031 exchange and you will have to pay capital gains taxes on the full sale amount of your property.
A qualified intermediary (QI) must be used to facilitate a 1031 exchange. This person will hold the sale proceeds during the interim time between the sale of the relinquished property and the purchase of the replacement property. The QI can not be related to either party involved in the 1031 exchange in any way, and they must carry certain levels of insurance to perform the role.
Unique Colorado Rules for 1031 Exchanges
Before 2009, there were no rules in Colorado regarding who could become a qualified intermediary and there was no license or certification required. This caused many problems and was remedied by a set of consumer protection laws in 2009, which states that QIs must maintain a fidelity bond of $1 million or more and an errors and omissions policy of at least $250,000. They also need your written authorization for a withdrawal from the escrow account if it holds more than $250,000.
The 1031 exchange process is very straightforward, with three main steps: simply sell your relinquished property, identify a replacement property within 45 days, and purchase your replacement property within 180 days.
Contact the Leading 1031 Exchange Company in Colorado!
If you have questions about a Colorado 1031 exchange or if you want to get started on an exchange today, contact us at TFS Properties! We will be more than happy to help you through the process.