Amazing Advice And Tips For Better Understanding 1031 Exchanges

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There’s a lot of economic uncertainty at the moment. Investors are seeking shelter in trusts and in healthcare real estate investments. 

Investors in stocks are getting hammered, but real estate investors are breathing easier. If you want to sell a property and move your assets quickly, you’d have to think about capital gains taxes. 

Capital gains taxes could defeat the purpose of moving your assets because you have to pay taxes on the profits of the sale. That is unless you do a 1031 exchange. 

Want to know how they work? Read this guide to understanding 1031 exchanges. 

What Is A 1031 Exchange? 

A 1031 exchange is the section in the IRS code that spells out how you can defer capital gains taxes when you sell investment properties. 

What you do is that you sell your investment property and use the funds from the sale to purchase a like-kind property. 

Like-kind property is a big gray area for investors because the section of the IRS code doesn’t do a great job spelling out the details. You could sell a four-plex and turnaround and buy an empty lot. 

The value of the properties comes into play. For example, if you were to sell a property and purchase one for a lesser value, you wouldn’t qualify for the exchange. 

It used to be that you could use a 1031 exchange in many types of investments, from art to intellectual property. When the Tax Cuts and Jobs Act was passed in 2017, that legislation limited the scope of 1031 exchanges. 

You’re only allowed to apply this rule when you are selling a property that is used for business purposes. Your business could own an office building or warehouse. If you needed to upgrade your facilities or needed more space, a 1031 exchange could be used to offset taxes. 

If you’re wondering whether or not a 1031 can be used on residential property, the answer is no. It’s only for business property. 

Does a 1031 exchange mean that you don’t pay taxes at all? No, your taxes are deferred. You’ll pay your capital gains taxes when you do sell the replacement property. 

Read more here about 1031 exchanges and a potential alternative to a 1031 exchange. 

The Rules And Deadlines Of 1031 Exchanges 

Does a 1031 exchange sound like a great idea to you? Your next step in understanding the rules that you have to comply with. 

You already know that 1031 exchanges require that you have to invest in real property that is like-kind. Here are the other rules that you need to know about. 

You Need A Qualified Intermediary 

You’re probably thinking that you can do the exchange on your own or use a real estate broker to handle the sale and purchase of your investment properties. 

You actually need a person called a qualified intermediary. They’re the ones that handle all facets of the 1031 exchange. They also handle the money involved in both transactions. The reason why they handle the money and you don’t is because when you touch the money, the IRS considers it income. 

That money then becomes taxable. With a qualified intermediary, they handle the finances to make sure you don’t pay taxes on the capital gains. 

The Deadlines 

You can think of a 1031 exchange as a transaction that comes in three phases. Each phase has its own deadline attached to it. 

The first phase is the sale of the initial property. The date of close of the sale is going to determine the other dates and deadlines in the 1031 exchange. 

After the sale comes the next phase of the transaction, which is to identify the replacement property. You have 45 days from the close of the sale to figure out the property that you want to purchase. You can identify several properties at the same time. 

The final phase is the purchase of the replacement property, which has to close 180 days after the sale of your first property. 

There are a couple of items to note with these deadlines. The first thing is that the days are counted in calendar days, not in business days. 

The second item has to do with Tax Day, which is usually April 15. Should April 15 come within that 180- day window, you have to make sure that your transaction closes by April 15. In other words, if you sell your property after October 15, your window to buy a replacement is shorter. 

When 1031 Exchanges Fail 

If a deal falls apart and you miss a deadline, the 1031 exchange would fail. This is important because if an exchange fails for one reason or another, you need to know what the consequences are and plan accordingly. 

In many cases, you’ll be able to defer your capital gains taxes the year after the failed exchange. It’s not a guarantee that you’d be able to do that. Check with your qualified intermediary to see if that tax path would work for your finances. 

Understanding 1031 Exchanges To Manage Your Wealth 

Like any other investment strategy, a 1031 exchange is a tool to help you build and manage wealth. When you’re learning about and understanding 1031 exchanges, it can be difficult to know what’s fully involved. 

You have to know the rules and deadlines of a 1031 exchange. You also have to be aware that these rules are subject to change, like when the rules changed in 2017. It’s always best (and necessary) to work with a professional to help guide you through the process. 

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