Finding Replacement Properties for 1031 Exchanges
Using a 1031 exchange can be daunting. There is so much information on the web about 1031 exchanges that it can make pursuing one challenging and feel like an uphill battle. However, the usefulness of a 1031 exchange can blow many real estate investors out of the water. Listed in section 1031 of the Tax Cuts and Job Act allows for deferred exchanges, meaning you can defer paying tax on immediate like-kind properties.
Selling investment properties can come along with a large tax bill that can make you feel discouraged from your big sale. It doesn’t have to feel this way, however. A 1031 exchange can allow you to prevent shelling out for hefty capital gains taxes on proceeds from the sale of a property, which are taxes you must pay on a sold investment.
While a 1031 exchange is complicated, the benefits can outweigh all the negatives. This exchange process has stringent guidelines that you will follow to qualify for your replacement property. However, upon meeting 1031 replacement property requirements, you can reap all the benefits of your property exchange. This guide will show you everything you need to do to have a successful 1031 exchange.
What is a 1031 Exchange?
A 1031 exchange is a form of real estate investing and refers to Section 1031 of the US Internal Revenue Code. A 1031 exchange is when a property owner swaps one investment property for another instead of selling it outright. Swapping makes the property owner eligible for a capital gains tax deferral as long as the property replacement is similar in value to the previous property.
The Internal Revenue Service has some rules for what properties qualify as a replacement. However, if the process for 1031 exchanges is submitted correctly, there is no hard limit on how many times you can use a 1031 exchange to defer capital gains taxes.
Some may refer to a 1031 exchange as a like-kind exchange. This exchange enables you to adjust your investment without cashing out. The rules for which properties can be exchanged or swapped are broad. For example, you may switch an apartment complex for a piece of land.
Usually, you are not allowed to swap for residential homes, but there are loopholes. There are some cases where vacation homes can be a 1031 replacement property, but these cases do not happen often. The best way to learn if you fit the exception or not is to contact a 1031 exchange professional.
A 1031 Exchange Timeline
In just three steps, you can get your 1031 exchange underway. These steps are easy but have many moving parts and people to consult.
Step One: Sell the Property
The first step of getting started with your 1031 exchange is to put your property up for sale. When your property is sold, you must then wait for the other party to accept the sale funds.
Step Two: 45 Days To Find a Replacement Property
When you have completed the sale of your previous property, you can then identify your next real property. This new property will be replacing your relinquished property. At this point, you will have to wait for the transfer of funds to the seller of the replacement property. After the funds are received, you are eligible to proceed with the third step.
Step Three: 180 Days To Finalize
Within 180 days, you must finalize and complete the process of buying your replacement property. This 180-day window is the final step in a 1031 exchange. Without completing this step within the specified timeframe of 180 days, you may be subject to capital gains taxes. A delayed exchange may also result in taxation.
1031 Exchange Replacement Properties And Where To Find Them
Finding the best property exchange can be challenging, but there are ways to find something profitable, suitable for your needs, and aligned with your values. It may be hard if you are unsure of what you are looking for, but using a real estate agent or broker can help.
You Only Have So Much Time
While you have 45 days to identify which property you want to replace your sold property, 45 days may end up feeling like it flew by so it’s smart to have a 1031 exchange specialist work with you to keep you on track. Finding a property is the hardest part. After locating the right property, you can finalize the purchase with your real estate agent.
After you have decided on the property, you will have 180 days to finalize the purchase. At this time, you may wish to inspect the property, learn of any repairs it may need, or tour the facility. A failure to finalize the sale at this time can result in your 1031 exchange falling through, and you may be subject to hefty capital gains taxes.
Look At The Whole Market
Selling a property and finding a new property may be difficult, but the options are nearly endless. Consider meeting with a real estate agent or broker to consider which options best fit your needs and desires. As mentioned, the rules for property swapping are relatively loose, and you may be able to choose a vastly different type of property than your last.
You may want to take a step back and view the whole market. There may be a cheaper property outside of your usual type that can serve you better.
Real estate brokers will know about the available properties in your area and help you decide which one is the best fit for what you need. You may contact us and we’ll help you find the right replacement property for your 1031 exchange.
View Co-Ownership Options
Two situations exist in which you can share ownerships of a 1031 exchange replacement property. These deferred properties can help you and another owner share the burden of new ownership.
Delaware Statutory Trust (DST)
With a Delaware Statutory Trust, you have the additional benefit of developing a portfolio of properties under your care – at one point or another – instead of being responsible for just one. This shared ownership of a property can help disperse the risk of ownership and avoid a lot of headaches and stress you may feel from a typical 1031 exchange.
However, Delaware Statutory Trusts often have a long-term window of investment. This co-ownership option means you may have to be involved in a property for five or more years at a time. While this can help your property remain safe against the fluctuated costs of the property market, it can be a discouraging prospect.
A Tenancy-in-Common allows you to have multiple properties in your care portfolio, like a DST. A TIC can offer more stability and security than a DST, however.
The disadvantage of a TIC is that there is a greater risk and responsibility that all co-owners bear. If the property has an issue, all co-owners may get into sticky situations.
A 1031 Exchange Replacement Property Can Help You Delay Taxes
Not only is a 1031 exchange beneficial for your selling portfolio, but it can defer capital gains tax for you. Properties exchanged allow you more freedom for liquid assets. This can enhance your investment opportunities in the property you have chosen as a replacement.
Exchanging properties can go on for as long as you like, helping you feel relief from capital gains taxes and keep your wallet feeling much more full. You may feel added benefits of this tax deferment on properties that gave you a loss. While it may seem daunting and challenging to proceed with a 1031 exchange for a replacement property, it can offer plenty of benefits.
By following the stringent guidelines for a 1031 exchange, you can reap the benefits of having newer property without having to shell out massive amounts of money on taxes. In addition, this property can be an invaluable investment opportunity.
Working With TFS Properties
Ready to find your perfect replacement property? Our real estate brokers have years of experience working with clients across the country with their 1031 exchange. We will make it hassle-free for you. Request a callback from one of our brokers today.