Using a 1031 Exchange, you can
1031 Exchange - Rules and Requirements
Section 1031 of IRC, commonly known as 1031 exchange or tax-deferred exchange, is an arrangement that allows investors to defer capital gains tax on exchanging an investment property for another like-kind property. Properties involved in 1031 exchanges must be held for use in trade, business or for investment purposes, which means only investment properties can be exchanged under Section 1031. For a transaction to qualify as a 1031 exchange, properties swapped must be like-kind.
Like-kind means a lot more than what you think...
The term like-kind refers to properties that are similar in nature. Many investors often get confused with this, as they think, properties exchanged under 1031 exchanges need to serve the same purpose. However, in no way, like-kind means properties serving the same purpose or used in the same way. For example, using a 1031 exchange, you can exchange a retail property for a student housing building or for a multi-family apartment or for any other income-producing property. The replacement property doesn’t need to be a retail property as well.
Beware of the deadlines...
Time plays a crucial role in 1031 exchanges. Every 1031 exchange investor needs to follow a set of guidelines established by the IRS and complete their exchange within a specified time limit. Not only this, but there is also a deadline for identifying the potential replacement property.
- 45 Days Identification Period – Soon after closing on the sale of the relinquished property, an investor gets a time limit of 45 days for identifying the potential replacement property. This time frame of 45 days is known as the identification period. Written identification of the potential replacement property must reach 1031 Corp. on or before the midnight of the 45th day.
- 180 Days Exchange Period – 1031 exchange investors get 180 days in total for completing every exchange they do, which starts the day the relinquished property is sold. So, the day you close on the sale of your relinquished property, that’s your Day Zero. Thereafter, you must close your exchange within 180 days.
Not to mention, there is no provision for extension of deadlines in 1031 exchanges. So, you better keep a watch on the time slippage or your exchange will no longer be valid, in case, you missed any of the deadlines.
Who is a Qualified Intermediary and why are they important for your 1031 exchange?A Qualified Intermediary is a person responsible for handling 1031 exchanges on behalf of the investors. As soon as you close on the sale of your relinquished property, the job of a Qualified Intermediary begins. They may also help you find a buyer for your relinquished property. Once you’ve transferred the proceeds from the sale of your relinquished property to the QI, they’ll start locating replacement properties for you. Under no circumstances, a 1031 exchange investor is allowed to hold the proceeds from their relinquished property. You may not like it, but it’s one of the rules framed by the IRS. The reason why the participation of Qualified Intermediaries is mandatory for 1031 exchanges is that there are handsome chances of an investor not being able to locate a replacement property within the specified time limit or may not be able to acquire it. Therefore, in order to make sure that a 1031 exchange is completed inside the exchange period of 180 days, the IRS has made the involvement of Qualified Intermediaries compulsory.
What you should be doing?
As a 1031 exchange investor, the first thing you should do is connect with an experienced 1031 exchange advisor. They could give you valuable advice on whether you should go for a delayed exchange, a reverse or a simultaneous exchange (different forms of 1031 exchange). It’s important that you plan everything in advance before initiating your 1031 exchange and an experienced 1031 exchange advisor can solidify your planning.