{"id":1274,"date":"2021-03-03T11:00:33","date_gmt":"2021-03-03T16:00:33","guid":{"rendered":"https:\/\/www.deeds.com\/articles\/?p=1274"},"modified":"2024-04-25T23:20:03","modified_gmt":"2024-04-26T03:20:03","slug":"for-property-investors-six-steps-to-a-1031-exchange","status":"publish","type":"post","link":"https:\/\/www.deeds.com\/articles\/for-property-investors-six-steps-to-a-1031-exchange\/","title":{"rendered":"For Property Investors: Six Steps to a 1031 Exchange"},"content":{"rendered":"\n
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Owners of U.S. investment or business properties should know\nabout a key tax-deferral provision allowed by the Internal Revenue Service: the\n1031 exchange<\/em>. Also called a like-kind exchange<\/em>, it\u2019s a way of swapping\none investment property for another. <\/p>\n\n\n\n

Upgrading to a more valuable investment property would\nusually involve a taxable sale. But by carrying out a like-kind exchange under Section\n1031 of the Internal Revenue Code, the property owner defers capital gains taxes.\nThis leaves more value for the investor to put into a replacement property.<\/p>\n\n\n\n\n\n\n\n

Like-Kind\nExchanges: The Basic Idea<\/h2>\n\n\n\n

Perhaps you own a rental townhome. It has appreciated\n$100,000 in value since you bought it. Now, you want to acquire a new, more\nvaluable property. Normally, you\u2019d have to sell, then buy, and owe tax on the\ncapital gains of $100,000 on the property you sold. But that tax can be\ndeferred if you trade up<\/em> for a more valuable property, rather than buy\nafresh, so you\u2019re not realizing the capital gains. <\/p>\n\n\n\n

How does this work? Professional accommodators help investors\nfind replacement properties and handle the transactions on their behalf. The\nfirm deploys a qualified intermediary<\/em> to buy the replacement property\nfrom the proceeds of the old investment property \u2014 making sure their client\ninvestors do not handle the cash.<\/p>\n\n\n\n

Here\u2019s a step-by-step timeline of the process:<\/p>\n\n\n\n

Step 1: Select a Qualified Intermediary. <\/h3>\n\n\n\n

The Iowa-based Federation of Exchange Accommodators, a trade group for 1031 exchange facilitators, offers an online directory listing their members\u2019 1031 exchange firms<\/a>. A tax expert with Section 1031 experience or your real estate attorney may be able to refer a firm they know. The firm you hire will create an agreement with you in order to have your property transferred to, and then from, the intermediary as a Section 1031 exchange. <\/p>\n\n\n\n

Step 2: Complete Your Current Sale. <\/h3>\n\n\n\n

Carry out the closing on the\nproperty to be replaced. Sale proceeds go to the qualified intermediary upon\nclosing, to be held in escrow until you\u2019re ready to close on the\nreplacement property. <\/p>\n\n\n\n

Never claim a Section 1031\nexchange if you have received cash proceeds from your property sale.<\/em><\/p>\n\n\n\n

Step 3: Have the Intermediary Locate a Replacement\nProperty. <\/h3>\n\n\n\n

The intermediary can locate rental\nor commercial properties that match the value you have in mind, and prepare to handle\na purchase agreement with a 1031 provision. <\/p>\n\n\n\n

Step 4: Identify Potential Replacement Properties\nWithin 45 Days. <\/h3>\n\n\n\n

Designate, in writing, the\npotential properties the intermediary may buy \u2014 generally up to a limit of\nthree options. It\u2019s best to avoid designating cheaper replacement properties\n(or saving money on the mortgage when making the leap), as the IRS would tax\nthe cash boot <\/em>at the capital gains rate. Boot <\/em>is the difference\nin prices between the exchanged properties.<\/p>\n\n\n\n

Step 5: Close on a Designated Replacement Property\nWithin 180 days.<\/h3>\n\n\n\n

Beyond the 45-day identification\nperiod<\/em> in Step 4, you have the exchange period<\/em>. All told, there\u2019s a 180-day\nlimit from the closing on your prior property\u2019s sale to the date you close on\nyour replacement purchase. <\/p>\n\n\n\n

While the deed of the new property\nwill go to you, the qualified intermediary uses the proceeds from the sale of\nyour prior property to buy the new property from its seller. Professional fees\ncan come out of the exchange funds. Taxes and financing charges must be paid\nseparately. (Repairs and improvements made after closing are not within\nthe exchange.) <\/p>\n\n\n\n

Step 6: Use the New Property as Another Investment\nor Business Property.<\/h3>\n\n\n\n

Hold and use the replacement\nproperty for business. Voil\u00e0! You have just used tax-deferred funds, and spent\nthem on a new, productive asset. <\/p>\n\n\n\n

In a reverse exchange, the replacement property is bought before\nthe prior property is sold. The exchange accommodation firm holds the title to\nthe new property during the exchange process. Otherwise, the steps are similar.\n<\/p>\n\n\n\n

Benefits\nand Risks<\/h2>\n\n\n\n
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In addition to what we\u2019ve noted above, there are clear\nbenefits to reap from a 1031 exchange. To list just a few:<\/p>\n\n\n\n