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Los Angeles 1031 Exchange Rules, Timelines & More

Selling Your Investment Property in Los Angeles

The Los Angeles 1031 exchange process can be difficult to navigate, but it doesn’t need to be. There are strict rules to follow and risks and benefits to consider. With a little research, you can likely use this code to your advantage.

Oceanfront Homes of Malibu Beach in California

What is a 1031 Exchange?

A 1031 exchange is a real estate deal that lets you “exchange” one investment property for another. By swapping these properties you can avoid paying capital gains tax on the first property, at the time of sale. A 1031 Exchange is a strictly regulated real estate transaction and you need to be sure to follow the IRS rules for the timeline and deadlines in which it can be performed. 

It was created to avoid unfair capital gains taxes on ongoing investments and to encourage reinvestment. As such, it’s not a tax loophole or way to “beat the system”. Rather, you’re using the system to your advantage, as intended. 

Benefits of Los Angeles 1031 Exchange

According to Vectra bank the monetary benefits from a 1031 exchange are as follows: 

  • The tax deferral: With a 1031 Exchange you can reinvest sale proceeds that you would otherwise pay capital gains tax on.
  • Diversify:  Leverage or spread your equity from the tax deferral to acquire more valuable property.
  • Consolidate: Consolidate the equity among new properties. These may be of increased value and also in new locations.
  • Gain income: Move equity from a non-producing property, such as empty land, into a higher income-producing purchase, like a commercial property.
  • Maintenance relief: Replace a difficult-to-maintain property with a managed property.
  • Increased depreciation: Choose a new property type as part of your exchange to take advantage of available depreciation.
  • Manage your estate: Make tax deferrals into tax savings and use those funds to plan your estate.

1031 Exchange Myths

A lot of people don’t understand how they can properly use the 1031 section of the tax code to their benefit. You may not think it applies to you, or that it’s too late to use it on your properties. Here are two common myths that can be busted right now. 

Myth: 1031 exchanges are only for the wealthy

When people hear “swapping investment properties” they often think of someone selling one huge, high-earning, rental property for another. But you don’t need to be a business tycoon, the average person can make use of the 1031 exchange. 

You can defer gain on the sale of your space when it’s used to purchase a replacement. This also applies to very small businesses or rental properties. For example, if you owned a small rental home (as opposed to an apartment building) or even a warehouse. 

Anytime you sell an investment property and use those proceeds for a replacement space, or possibly even a piece of land, you can likely defer the tax on the sale. 

If done correctly, with a qualified intermediary, you can profit enough to continue building up your investment portfolio. 

Myth: A 1031 exchange must be simultaneous

About a hundred years ago a 1031 exchange did need to be simultaneous. That’s not true anymore. 

The most common type of 1031 exchange is a forward exchange. In this scenario, the proceeds from the sale of one asset are used to purchase an asset considered to be like-kind within 180 days. 

There are other possible ways to go about replacing your relinquished property in a 1031 exchange. You could, for example, purchase the replacement property 180 days before the sale in a reverse exchange

California home property

1031 Exchange Rules

Can you take advantage of the 1031 Exchange tax section? Look at this list to get an idea if your holdings and selling plans meet the criteria. 
  • Property use: The properties being exchanged must be held for productive use in a trade or business, or investment. It can not be a primary or vacation residence for personal use. 
  • Designated Usage: There is no timeline to establish the intended use of the newly acquired property. But it must be treated as an investment. 
  • Like-Kind: the new property needs to be similar to the old property. For example, one rental property for another. 
  • Timeline: The final purchase must be completed within 180 days of the original sale. You should have had the replacement property designated within 45 days of the sale of the original property. 
  • Valuation: The replacement property needs to be of equal or greater value to the relinquished property.
  • Funding: The replacement property needs to be purchased with the proceeds of the sale of the relinquished property to get the tax deferral.
  • Qualified intermediary: The intermediary must hold sale proceeds between the sale of the original property and the purchase of the new property.

Unique Rules for 1031 Exchange in Los Angeles

Some of the rules above are different if you’re exchanging a California property either within California, or purchasing the replacement property in a new state.
  • Bonds for intermediaries: In California, you still require a qualified intermediary to facilitate the exchange. In this case, the intermediary has to maintain a bond of a million dollars or more. They can deposit one million in securities, irrevocable letters of credit, or cash. They may also deposit all of the exchange funds into a qualified trust account, or in escrow.
  • The Intermediary needs to maintain errors and omissions insurance: This insurance must be maintained at a minimum of  $250,000 (or deposit cash, securities, or a letter of credit in the same amount). Exchange funds cannot be commingled with the intermediary’s operating funds and cannot be loaned or transferred to an affiliate of the intermediary (except for an affiliated financial institution). 
  • California filing requirement: You must report a like-kind exchange in California (FTB 3840) if you do both of the following:: 
    • Perform a like-exchange of real property in California for real property outside California.
    • Use IRC 1031 to defer any loss or gain.
  • You are required to file FTB 3840 every year
    • That you defer the gain or loss.
    • If you exchange the out-of-state property for another out-of-state property using another 1031 exchange.
    • Until you pay and report taxes to California on your deferred gain or loss.
    • Donate the exchanged property to a not-for-profit.
    • Until you die. 

Straight Forward Process

This may seem like a lot of information but remember, it all boils down to three easy steps:

  • Sell the property you intend to relinquish.
  • Identify your replacement property within 45 days of the sale of your relinquished property.
  • Purchase the replacement (like-kind property) and close within 180 of selling the relinquished property using a qualified intermediary. 

Contact the Leading 1031 Exchange Company in Los Angeles!

With the leading 1031 exchange company in Los Angeles at your side, you can easily navigate these steps. 

2021 Legal Disclaimer
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