1031 Exchanges
How it Works
- The ‘1031 Exchange’ is a tax-break from the IRS that allows real estate investors to sell their investment property without paying capital gains taxes.
- Typically, when a piece of investment real estate is sold, taxes take about 30-40% of the profit. If the property qualifies for the 1031 exchange tax-break however, these taxes DON’T have to be paid!
- A 1031 exchange must be set up BEFORE an investor closes on the property they’re selling. The investor then has 45 days from the closing date of his/her sale to identify the properties he/she is planning on reinvesting in and, in total, 180 days from the closing date of his/her sale to actually close on any of the replacement properties that he/she identified.
- To fully avoid the 30-40% in taxes, the 1031 exchange tax-break requires that an investor reinvest all of the cash equity from their sale into new investment property of equal or greater value (relative to the sales price).
Types of Exchanges
- Standard Exchange: The Standard Exchange is the best option for those with a straightforward exchange strategy. This is most commonly used by property used by property owners who want to directly exchange one property for another without paying capital gains taxes. The standard exchange is a simple sequence in which the exchanger sells their relinquished property first and purchased the acquired property second. In the 180-day period after the relinquished property’s closing date must occur, the qualified intermediary takes custody of the relinquished property’s funds and applies them to the purchase of the qualifying identified property in order to acquire this property with tax-free exchange funds, in compliance with IRS Section 1031, which states that exchangers cannot directly receive tax-free funds from a 1031 Exchange.
- Reverse Exchange: The reverse exchange is best for property owners who want to purchase a property first and sell properties they currently own within 180 days of the closing date of the acquired property. This sometimes serves investors who have an expiring opportunity that can’t wait for the sale of current properties.
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