Mar 18, 2022
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:
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:
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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