Delayed 1031 exchange is a popular choice among real estate investors..It allows you to identify and acquire a new property with higher returns than the original one while avoiding capital gains taxes. You can sell one property and take some time to purchase another like-kind property. It's a terrific way to diversify your portfolio or combine your real estate holdings. However, the delayed exchange is subject to stringent replacement property 1031 exchange rules. Here is all you need to know before you initiate a 1031 delayed exchange.
What Is 1031 Delayed Exchange
In simple terms, a 1031 Delayed Exchange is when you transfer the property you own before acquiring a new property. Unlike a simultaneous 1031 exchange, the relinquished property and the replacement property need not be closed at the same time.
You have to, however, keep in mind the 1031 delayed exchange time limit. From start to end, you have 180 days to complete the transaction. This time period is termed as Exchange Period. That means you have exactly six months, or 180 days, from the time you sell the relinquished property until you close on the replacement one.
According to the IRS, you have 45 days to identify a replacement property–in writing. This is called the Identification Period. You must include a clause in the purchase contract specifying that the relinquished property and the replacement property will be used in a 1031 exchange.
You must also identify three separate properties, and after 45 days, you cannot add any more properties.
Some investors often go in unaware that the 45-day term is included in the 180-day timeframe. Plus, regardless of when you sell the relinquished property, the replacement property must be purchased before the tax filing deadline.
The time limit is strict and non-negotiable, even if the 45th or the 180th day ends up being a weekend or a legal holiday.
Things to Keep in Mind
If you buy a replacement property that is priced at less than the relinquished property, you will have to pay capital gains taxes on the difference (called boot). This also includes your debt service. If the mortgage on the new property is smaller than the mortgage on the relinquished property, you may still owe capital gains taxes.
Also, you can put extra money into the renovation of the replacement property, which would be tallied toward the property's final net worth.
If you want to know more about 1031 replacement property rules, check out the 1031 Exchange Timelines & Rules on the 1031 Granite website.