A 1031 exchange can be a great option for investment buyers who want a loophole to the hefty tax that can be associated with large commercial property sales. However, since most people aren’t familiar with Internal Revenue Code Sections even after filing taxes year after year, here is a quick and simple guide to the 1031 exchange. Speak with your TLT agent for more information regarding performing a 1031 exchange on your investment property.
- A 1031 exchange is a provision for investment and business properties. You cannot use a 1031 to do a primary residence housing swap, although a narrow loophole does exist for vacation properties.
- A 1031 exchange does not have to be used for real estate. In certain cases, a 1031 may be performed for personal property such as paintings and interests as a tenant in common.
- The term “like-kind,” used to describe the type of exchange allowed by a 1031 is broad but complicated. Be sure to discuss all possible options with your agent.
- You may, and most likely will, perform a delayed, three-party exchange, wherein an intermediary holds the funds from your property sale and uses them to buy a replacement property for you. This three-way swap is also known as a Starker exchange.
- Timing is key in a 1031 exchange. The first rule being that within 45 days of your property sale, you must designate a replacement property in writing to your liaison.
- You may designate multiple potential replacement properties with the contingency that you will close on one of them. Ask your broker about the conditions of this practice.
- The second timing rule in a Starker 1031 exchange is that you must close within six (6) months of sale. The timing rules are concurrent, meaning that the sooner you designate your replacement property, they longer you will have to close. You receive a total of 180 days to complete the entire process.
- If there is a balance after the intermediary purchases your replacement property, the case will be returned to you at the end of the 180 days as a “boot.” These monies will be taxed as partial sales proceeds or capital gain.
- Any mortgages and other debt that is relinquished during the 1031 exchange, therefore reducing your liability, will also be classified as boot income and taxed.