A Brief Guide to the Section 1031 Exchange

What can you do to legally reduce the amount of tax you have to pay? If you invest in real estate a 1031 exchange, named after Section 1031 of IRS Code, is a valuable resource that you may want to look into. It might allow you to increase your net worth without having to pay up to 35% in taxes.

A 1031 exchange is a transaction in which you exchange a property for another similar property and defer the tax implication of the sale. To give a practical example: Imagine you buy a property for $200,000 and sell it for $300,000. You can invest the profit of $100,000 into another property and not have to pay capital gains tax.

The Requirements

Deferred/Delayed Exchange

A deferred/delayed exchange is most common. Once you’ve sold your property, you can take 45 days to identify other properties of equal or higher value. You have 180 days from the time you sold the original property to acquire the new one. One of the following conditions must apply in order for the new property to be considered valid.

  • You identified up to three properties to potentially purchase within the initial 45 days. In this case their total market value does not matter.
  • You identified as many potential purchases as you want in the initial 45 days, and their total market value is a maximum of 200% the value of the property you sold.
  • You identified unlimited exchange properties, receiving a minimum of 95% of their value within the exchange period.

Simultaneous Exchange

You also have the option to pursue a simultaneous 1031 exchange. In this case, you would close on the replacement property as soon as you close on the original.

Reverse Exchange

In a reverse 10 31 exchange, you can acquire the replacement property before ownership of the original property is transferred to the purchaser.

Type of Property

When choosing a new property, it must be “like kind.” This means that it is another qualifying type of real estate. Any business or investment property qualifies while residential property does not.

Using a QI

IRS safe harbor provisions require you to use a Qualified Intermediary (QI) if you opt for a deferred exchange. The QI is a third party who keeps the proceeds from the sale of the original property in escrow, then uses that money to buy the replacement property on your behalf.

Who can help me with a 1031 exchange?

If you are investing in real estate and need help with a 1031 exchange or have questions on this topic, the Drucker & Mattia team is here to help. We encourage you to contact us today!

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