The Do's And Don'ts Of A 1031 Exchange
Updated: Mar 29, 2022
Successful real estate investing can be very rewarding, but it’s far from easy. A 1031 real estate exchange is the perfect example. Simply put, these involve selling a piece of investment property and being able to defer any capital gains taxes by reinvesting in another similar type of property of equal or greater value. However, there is a multitude of rules and stipulations spelled out in Section 1031 of the Internal Revenue Code.
It’s not exactly light reading, but don’t let complexity get in the way of a good thing. The professionals at an experienced investment company such as Precision Global Corporation can thoroughly explain how to do a 1031 exchange involving real estate. To get you started, here are some basic do’s and don’ts.
Determine your investment goals first. If you’re after short-term gains, this is not the investment vehicle for you. Properties appreciate over time, not overnight. A 1031 exchange is especially suitable if you’re looking to build your net worth while deferring capital gains taxes until some future date when it’s more advantageous to cash out.
Learn exactly what a 1031 real estate exchange is. As with any investment, you don’t want to get locked into something only to learn you don’t have the flexibility or cash flow you expected. Study the details.
Understand the definition of “like-kind” property. We’re discussing only 1031 real estate exchanges here, and fortunately the IRS rules say that real properties are generally of like-kind — even if, say, you’re exchanging an apartment complex for unimproved land. An example of something that would not qualify for a 1031 exchange would be selling a coin collection and using the proceeds to buy land as an investment.
Be prepared to defer your exchange. If you close on a property sale and are unable to perform the exchange immediately afterward, the exchange is technically deferred. In these cases, your funds must go to an intermediary until your subsequent investment is completed, or the exchange won’t be fully eligible as a 1031 exchange.
Report the exchange to the IRS for the same tax year. Form 8824 covers like-kind exchanges.
Don’t expect to exchange personal property. Your primary residence or a vacation home used primarily for personal use does not qualify for a like-kind exchange.
Don’t expect to escape the capital gains tax bite altogether. The taxes on your gains are deferred, not eliminated. When you cash out in the future, preferably at an advantageous time, Uncle Sam will want his due.
Don’t carry out an exchange involving a property that isn’t within the U.S. According to the IRS, property outside the country is not like-kind to property within the U.S.
Don’t take control of cash before completing the exchange. An intermediary that you have thoroughly vetted should hold onto your sale proceeds until the 1031 exchange is complete. Otherwise, some of the funds could be subject to capital gains taxes in the year of the sale. Notably, it’s against IRS rules to be your own intermediary.
Don’t ignore timing constraints. Once you sell a property for 1031 exchange purposes, you have only 45 days to identify your subsequent investment property and 180 days to complete the exchange.
Don’t invest in a cheaper property. If your new investment property is worth less than the one you’ve sold, you may pay capital gains taxes on the difference in the same tax year of the sale rather than on a deferred basis.
Need more information on how to do a 1031 exchange? Precision Global Corporation is here to help. Contact us today to get started.