The Basics of 1031 Exchanges — and Why It May Be a Good Option for You
For owners who hold investment property, a 1031 Tax-Deferred Exchange is one of the most powerful tools available when it comes time to sell. Whether you’re looking to reposition equity, consolidate or diversify your holdings, or increase your monthly cash flow, a 1031 exchange can give you significantly more purchasing power by deferring the capital gains taxes you would otherwise owe on a sale.
If you’re not familiar with it, the 1031 Tax-Deferred Exchange is a section of the Internal Revenue Code that allows a seller to defer paying capital gains taxes on an investment property when the proceeds are reinvested in “like-kind” assets. In other words, you can sell your investment property and acquire another of equal or greater value while deferring those capital gains taxes — letting you re-invest dollars that would have otherwise gone to the IRS.
Reasons to Use a 1031 Tax-Deferred Exchange
There are many reasons investors choose a 1031 exchange:
Increased Cash Flow / Income: Cash flow can increase when an investor exchanges one property for another of greater value. For example, you might sell a vacant parcel of land that produces no monthly income and purchase an income-producing property such as a single-family home, condo, or apartment complex.
Increased Purchasing Power / Leverage: Because the investor re-invests the funds that would otherwise have gone to capital gains taxes, many are able to purchase more valuable properties — building long-term wealth and, in turn, generating higher monthly rents.
Consolidation or Diversification: This can be one of the most beneficial aspects of a 1031 exchange, especially with significant capital gains. With the added purchasing power, an investor can sell a single property and exchange it for multiple properties, an apartment complex, or even a commercial property. “Like-kind” assets can be purchased anywhere within the United States within the required time frames.
Basic Requirements for a 1031 Tax-Deferred Exchange
Taxpayer Requirements: The taxpayer must acquire title to the new asset in the same manner the title was held on the property being exchanged. For example, if you held title as an individual on the property being sold, the property being purchased must be titled the same way. There are exceptions an exchange accommodator or tax professional can identify.
Deadlines and Identification: There are two deadlines, both beginning on the date the first property transfers:
- The replacement property must be identified within 45 days.
- The exchange must be completed by whichever of these is earlier:
- 180 days from the closing date of the relinquished property, or
- the due date of the taxpayer’s federal income tax return (including extensions).
Replacement properties must be identified in writing by the taxpayer. Up to three replacement properties can be identified without regard to their fair market value. Alternatively, any number of properties can be identified, as long as their combined fair market value does not exceed 200% of the fair market value of all relinquished properties.
As a property management company, we see many of our clients engage in 1031 exchanges. We’re in a unique position to relinquish and acquire assets within our own management portfolio — often giving our owners the chance to buy from or sell to our other owners before properties hit the open market. Many of our owners are looking to sell or exchange properties that are already tenant-occupied, creating opportunities for clients interested in acquiring investment property. If you’re thinking of selling, exchanging, or purchasing investment property, contact our office for a personalized market analysis.
The information above is a general overview of the 1031 Tax-Deferred Exchange and is not intended to be a complete analysis of the Internal Revenue Code. Golden Key Properties, Inc. is a real estate company that represents buyers and sellers in the sale or purchase of real estate; it is not an exchange accommodator, tax advisor, or legal representative. Please consult your tax professional or legal representative to determine whether a 1031 Tax-Deferred Exchange is right for you, or contact your property account manager at Golden Key to discuss your options and receive a referral to one of our preferred exchange accommodators.