If you’re a real estate investor, a 1031 exchange is a process that enables you to make the most of the capital gains from your sale of the property. You can use this tool to trade up for higher-value properties from the process of your property sale and increase your overall wealth. But before you plan on utilizing the various benefits of a 1031 exchange, here are some important things you need to know.
What is a 1031 Exchange?
A 1031 exchange is a type of transaction approved by the IRS that allows real estate investors to defer capital gains tax from a property sale and use the entire amount for reinvestment on another property. The name is derived from Section 1031 of the U.S. Internal Revenue Code, which permits investors to defer capital gains taxes from the sale of the property on condition that the amount is used for purchasing a ‘like-kind’ 1031 exchange investment real estate property.
The IRS has a very broad scope in its definition of what ‘like-kind’ properties are. According to them, 1031 exchange investment properties are like-kind if they are of the same nature or character regardless of the difference in grade or quality. What is more specified is the type of property that qualifies for a 1031 exchange. Any property is eligible for this type of transaction, as long as it has a productive use in a trade or business, or is for an investment purpose. This means that primary residences do not meet the requirements.
What Are The Process Involved in a 1031 Exchange?
To utilize a 1031 exchange for reinvesting the proceeds of your property sale, you’ll have to follow these steps.
Step #1 Identify The Property You Want to Buy And Sell
The first thing you need to do is determine the property you plan to sell and the property you’ll spend the proceeds on. While doing this, ensure that the properties in question are ‘like-kind’ and meet the criteria for the exchange.
Step #2 Choose a Qualified Intermediary
A 1031 exchange cannot be completed without the involvement of a qualified intermediary (QI). This party is responsible for handling your 1031 exchange transaction, taking up the duty of holding your fund in escrow, and transferring it to the seller of your replacement property.
It is crucial that you choose a credible, competent, and trustworthy QI so that you don’t lose money, miss deadlines, or end up in a situation where you need to pay taxes now and not later.
Step #3 Inform The IRS About Your Transaction
Once you’ve completed your transaction, you’ll need to inform the IRS through IRS Form 8824 with your tax return. In the form, you’ll provide a detailed description of the properties, a timeline, explain who was involved in the process along with details of the money involved.
How Much Time do You Have To Complete a 1031 Exchange
Keep in mind that when performing a 1031 exchange you have specific timelines to adhere to. Failing to meet deadlines could prevent you from reaping the benefits of tax deferrals.
After the sale of your relinquished property, you have 45 days to find potential replacement properties. And you must close on the replacement property within 180 days of selling your relinquished property. You must document everything in writing and share them with your seller and qualified intermediary.
Partner WIth Granite Exchange Services
We are certified exchange specialists who provide 1031 exchanges to real estate investors. We are the nation’s most elite, full-service 1031-qualified intermediary and we can guide you through the process smoothly. Contact us today and speak to our experts to learn how we can help you.