A 1031 exchange allows you to swap your business investment for another without paying capital gains tax, even if you make money on the deal. No tax comes due until you sell the property, making a 1031 a great way to increase the value of your investment.
Here are the 1031 exchange basics, like-kind exchange rules that you need to know – a 1031 exchange for dummies!
1031 Exchange Basics
According to the like kind exchange rules, there are two kinds of property, personal and real. Property that you are using for a business investment is known as real property. All that the ‘like’ in like-kind means is that you must swap one business investment for another business investment.
If you have a personal property, you can’t swap this for real property – and vice versa. But there’s no rule that prevents you from swapping a residential letting property for a commercial one, for example.
It Doesn’t Have to Be a Straight Swap
You’d have to be lucky to find someone wanted to swap exactly the sort of investment you were looking for, in exchange for the property that you have. It does happen, but life isn’t always that simple.
Instead, intermediaries work to enable more complex exchanges called Starker exchanges. In this sort of like kind exchange, the swap will be between three individuals; one who is receiving your property and one who you are receiving a property from.
Timing Is Important
If you’re taking part in a Straker 1031 tax-deferred exchange, you have 45 days after you have relinquished the property to let the intermediary know what you want to do next. You don’t have to make a final decision right away, but you must send them a list of up to three properties that you are considering.
The second important date in the 1031 exchange timeline is 180 days; by then you must have closed the exchange. That is 180 days from when you relinquish your property, not from day 45 when you express your interest in others.
Consider Cash & Debt
As part of the like kind exchange rules, the tax is payable on any cash that you make from the exchange. So, if you exchange your property for one of lesser value and take cash out? You will have to pay tax on that money.
You will also need to consider any debt or mortgages on the properties involved. Let’s say you swap for a property of equal value; however, your property had a $100k mortgage, and the new property only has $50k. You are making a deal that gives you less liability, and you would need to pay tax on that amount.
1031 For Investment
If you’re looking to start a real estate investment business, then it’s worth keeping 1031 exchanges in mind as a way to boost your portfolio in the future. Property is just one investment opportunity for entrepreneurs, but we hope this guide to 1031 exchange basics was useful.
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