What is a 1031 Exchange?
Today, real estate prices in many U.S. cities have exceeded the “bubble levels” of a decade ago, and many investors believe that now is the prime time to exchange properties in high-priced markets for cash flowing properties across the country. This is where 1031 Exchange comes into play, and here’s what you need to know about it.
Also called a Starker Exchange or Like-Kind Exchange, defined under section 1031 of the IRS Code, it is a powerful tax-deferment strategy used by some of the most financially successful investors.
Basically, a 1031 Exchange allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long another “like-kind property” is purchased with the profit gained by the sale of the first property.
Let’s say you are investing in properties that are low-income and high-maintenance – you could exchange this investment for a low-maintenance investment without needing to pay a significant amount of taxes; or, you could move your investments from one location to another – without incurring the tax liability.
Traditionally, a 1031 exchange is where you literally exchange one property for another property of like-kind; however, the likelihood that the property you want is owned by someone who wants your property is slim. According to Forbes, this is why “the vast majority of exchanges are delayed, three party, or Starker exchanges.
In a delayed exchange scenario, you’ll need a middleman who will hold the cash after you “sell” your property, and who will use it to “buy” the replacement property for you a three-party exchange treated as an exchange.
To use the 1031 Exchange effectively, you must exchange one property for another property of similar value, and in the process avoid capital gains, at least for a while. The rules require that both the purchase price and the new loan amount be the same or higher on the replacement property. An investor will eventually cash out and pay taxes, but in the meantime, he or she can trade properties without incurring a sudden tax obligation.
There are four types of 1031 Exchanges investors can choose from: Simultaneous, Delayed, Reverse or Forward, and Construction or Improvement.
There are many rules and qualification requirements that you must comply with in order to perform a successful 1031 exchange. The biggest advantage of using this strategy is that you can avoid having to pay capital gains taxes on the sale of an investment property – a huge benefit for real estate investors who know which markets are primed to grow next.
It can also lead to demise for beginners, and anyone who doesn’t understand the changing nature of the real estate market. Here’s what that means: if you want to maximize the benefits of your exchange, it’s important that you invest in a market that has good potential for growth in the future. Choosing your replacement property wisely is paramount, since if you were to sell your replacement property, even at a deficit, you would still be accountable for the capital gains on the initial property.
This blog covers just a basic overview of what the 1031 exchange. To understand the intricacies of real estate investing, real estate market cycles, and growth opportunities, seek professional help before you dive deeper. The truth is that a 1031 tax-deferment can be incredibly complicated, and even a small mistake can put you at risk for the deferment of your capital gains taxes.
Always seek professional help with the determination of whether a property qualifies for 1031 Exchange, explanation, review and explanation of time limitations involved and of contract with “qualified intermediary,” representation at closing for sale of property and at closing for purchase of property, and guidance on proper transfer of funds to comply with the 1031 Exchange Law.
Our proficient real estate lawyersare well equipped to assist you with real estate laws and provide support with legal challenges when planning, structuring, and conducting investment transactions.
Take steps today to set yourself up for greater chance of success in real estate with a piece of mind from day one knowing your rights and interests are protected – contact Levin Law Group today: