1031 Basics - Tax Deferred Investing

The 1031 Exchange allows an investor to sell property they have been HOLDING as investment/rental property or property they have used in their business and acquire like-kind replacement property that they INTEND to HOLD as investment property or property to be used in their business without incurring any capital gain tax liability.

By deferring 100% of your capital gain tax liability you retain 100% of your net cash proceeds from the close of the transaction to reinvest in the next like kind replacement property and allows 100% of your cash to continue working for you instead of the Federal government.

Qualified Use Test

The investor/taxpayer/exchangor must have the intent to hold any property involved with a 1031 exchange for investment or business property in order to satisfy the Qualified Use Test.

If you actually intend to buy, fix-up and then flip a property you do not have the intent to hold and therefore do not satisfy the Qualified Use Test and technically do not qualify for 1031 exchange treatment.

Like Kind Replacement Property

Any type of real estate is considered to be like-kind to any other type of real estate for 1031 exchange purposes provided the taxpayer has held the properties for investment or use in their business and therefore satisfied the Qualified Use Test.

Examples

• Sell an Apartment complex and buy a commercial/industrial property

• Sell a couple of single family homes and acquire a retail center

• Sell vacant land and acquire multi-family property/apartment

• Sell one Single family residence and buy 3 more single family properties

Types of 1031 Exchanges

There are three basic types of 1031 Like Kind Exchange transactions: Forward (Delayed), Reverse or Build-To-Suit 1031 Exchanges.

The forward 1031 exchange allows the investor to sell his or her relinquished property first and then acquire the replacement property later.

The reverse 1031 exchange allows the investor to acquire his or her replacement property first and then sell the existing relinquished property. This structure eliminates the risk and stress involved with a forward 1031 exchange and the 45 day identification period.

The final structure is the build-to-suit 1031 exchange where the investor can use his or her exchange proceeds to purchase replacement property and construct improvements on the property as part of the 1031 exchange transaction.

Deadlines

You have two time frames to adhere to when you are structuring a 1031 exchange transaction. They both start running the day you close on your relinquished (sale) property or replacement (acquisition) property. So, if you closed your transaction and title has been conveyed today, then tomorrow would be day number one for both your 45 and 180 day deadlines.

45 Day Identification Period

You have 45 calendar days to identify what you intend to acquire (or sell in a reverse exchange). Most taxpayers will use the three (3) property rule, which means you identify up to but not more than three (3) properties as potential like kind replacement properties. You may acquire one, two or all three of the identified properties (the 1031 exchange is a great method for investors to diversify from one to many or to consolidate from many into one properties and restructure their portfolios accordingly with out paying any capital gain taxes).

180 Day Completion Deadline

You have a total of 180 calendar days in order to complete your 1031 exchange and receive title to your replacement propertiers (or transfer title to your relinquished property in a reverse exchange). It is not 45 plus 180 calendar days. It is a total of 180 calendar days from the close of your relinquished property. It is also straight calendar days…there is no time off for weekends

Qualified Intermediary (Accommodator)

The investor must make sure that he or she has retained the services of a professional Qualified Intermediary and the Qualified Intermediary must be assigned into the Purchase and Sale Agreement and Escrow Instructions before the transaction closes.

Exchange Fees

The majority of the major Qualified Intermediaries will charge about $750.00 for forward 1031 exchanges, $4,000 to $5,000 for a reverse or build-to-suit 1031 exchanges, and more if the transaction is exceptionally large.

I hope this is a good start if you are thinking about selling an investment property. I cannot cover all aspects of the exchange in this article but will be happy to assist if you have any questions