5 Things All Real Estate Investors Need to Know About 1031 Exchanges

NEW YORK - March 18, 2022 - (Newswire.com)

iQuanti: A 1031 exchange, also referred to as a like-kind exchange, helps real estate investors upgrade to like-kind properties while deferring capital gains. But the process of executing a like-kind exchange needs to be followed precisely to avoid taxation. In advance of a 1031 exchange, here are five things all real estate investors need to know. 

1. Deferring Capital Gains Does Not Mean Avoiding

It's a common misconception that gains transferred through a 1031 exchange are tax-free. The truth is real estate investors will need to pay taxes on gains eventually, but a 1031 exchange enables them to reinvest the proceeds, thereby pushing taxes off to a future date. 

2. Following Tight Timelines is Critical

Executing a 1031 exchange means managing some fairly tight timelines. Especially in a hot real estate market, it can be challenging to meet requirements when properties are on and off the market in record time. The most important timelines to understand are:

• You must identify the replacement property (or three eligible properties, one of which you'll buy) within 45 days of closing on the relinquished property. If you fail to identify a property after the 45th day, the original sales transaction will be open to regular taxation. 
• You must close the entire transaction within 180 days of closing on the relinquished property. 

3. Having a Team of Professionals Can Help Navigate the Process

It's wise for any real estate investor to put a team in place before beginning a 1031 exchange. The team may consist of a: 

• Qualified Intermediary: This is a person or company responsible for putting funds for the exchange properties in escrow and helping an investor stick to the IRS rules around 1031 exchanges. If you fail to designate a qualified intermediary or transfer funds into one of your personal or business accounts, the capital gains become taxable, and you'll 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 relinquished property and purchase of the replacement property. An investor can certainly choose to work alone, but a real estate agent may be able to recommend attorneys and accountants and find eligible replacement properties you may not have known about on your own.

4. Purchasing a Property of Lesser Value Has Tax Implications

By design, the 1031 exchange encourages investors to upgrade to properties of equal or greater value. But you can buy a lower value property too. If you decide to purchase a property of lesser value, you'll be taxed on the difference between the purchase price of the replacement property and the sale price of the relinquished property. This taxable amount is referred to as the boot. A tax professional can help assess the exchange to determine the boot amount, if applicable.

5. Buying Multiple Replacement Properties is Allowed

A like-kind exchange doesn't need to be a one-to-one property replacement. Investors can sell a property and use the proceeds to purchase several properties that qualify as like-kind. The only stipulation is that investors need to purchase from the list of three potential replacement properties identified within the 45-day window after the relinquished property sale. 

The Bottom Line

A like-kind exchange can be advantageous for real estate investors looking to build their investments over time. But it's essential to be savvy about how 1031 transactions work to ensure tax-favored capital gains treatment.

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Original Source: 5 Things All Real Estate Investors Need to Know About 1031 Exchanges