NEW YORK – March 18, 2022 – (Newswire.com)
iQuanti: A 1031 exchange, also known as a like-type exchange, helps real estate investors switch to similar properties while deferring capital gains. But the process of executing a like nature exchange must be followed precisely to avoid taxation. Before a 1031 exchange, here are five things every real estate investor should know.
1. Deferring capital gains does not mean avoiding
It is a common misconception that earnings transferred through a 1031 exchange are tax exempt. The truth is that real estate investors will eventually have to pay taxes on the gains, but a 1031 exchange allows them to reinvest the proceeds, thus deferring the taxes to a later date.
2. It is essential to meet tight deadlines
Executing a 1031 exchange means managing quite tight deadlines. Especially in a booming real estate market, it can be difficult to meet requirements when properties are on the market and off the market in record time. The most important deadlines to understand are:
- You must identify the replacement property (or three qualifying properties, one of which you will purchase) within 45 days of closing the abandoned property. If you are unable to identify a property after the 45th day, the original sale transaction will be open to regular taxation.
- You must close the entire transaction within 180 days of closing the abandoned property.
3. Having a team of professionals can help navigate the process
It is wise for any real estate investor to set up a team before starting a 1031 exchange. The team can consist of one:
- Qualified Intermediary: This is a person or company responsible for placing funds for escrow exchange properties and helping an investor comply with IRS rules around 1031 exchanges. If you fail to appoint a qualified intermediary or transfer funds into any of your personal or business accounts, capital gains become taxable and you will lose the tax-sheltered benefits of the 1031 transaction.
- Real estate agent: Investors may choose to work with a real estate agent to facilitate the sale of the abandoned property and the purchase of the replacement property. An investor can certainly choose to work alone, but a real estate agent may be able to recommend lawyers and accountants and find eligible replacement properties that you may not have known about on your own.
4. Buying a lower value property has tax implications
By design, the 1031 exchange encourages investors to upgrade to properties of equal or greater value. But you can also buy a lower value property. If you decide to buy less valuable property, you will be taxed on the difference between the purchase price of the replacement property and the sale price of the abandoned property. This taxable amount is called the boot. A tax professional can help assess the exchange to determine the start-up amount, if any.
5. Purchasing multiple replacement properties is permitted
A like-for-like exchange need not be a one-to-one property replacement. Investors can sell one property and use the proceeds to purchase multiple properties considered similar. The only stipulation is that investors must buy from the list of three potential replacement properties identified within the 45-day window after the derelict property is sold.
A like-for-like exchange can be beneficial for real estate investors looking to grow their investments over time. But knowing how 1031 transactions work is key to ensuring favorable tax treatment of capital gains.
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5 things every real estate investor should know about 1031 Exchanges