There are many compelling reasons to consider a tax-deferred 1031 exchange when selling an investment property. However, such exchanges can be complex. There are deadlines, restrictions, and rules you need to follow.
If you’ve been thinking about completing a 1031 exchange, the answers to the following frequently asked questions may help you feel more at ease with the process.
What Exactly is a 1031 Exchange?
A 1031 exchange is a transaction that allows property investors to defer capital gains taxes and depreciation recapture by replacing one investment property with another. The term “1031 exchange” comes from section 1031 of the Internal Revenue Code, which establishes the rules for a successful exchange.
How Do I Qualify for a 1031 Exchange?
Any individual who owns an investment or business property can engage in a 1031 exchange. To qualify, you must sell your property (the “relinquished property”) and purchase a “like kind” property (the “replacement property”) while following all the 1031 exchange rules.
According to the IRS, a wide variety of taxpayers are eligible participate in a 1031 exchange:
- C corporations
- S corporations
- General partnerships
- Limited partnerships
- Limited liability companies
- Any other taxpaying entity
What Types of Properties Can I Use?
To qualify for a 1031 exchange, both the relinquished and replacement properties must be “held for productive use in a trade or business or for investment” and be “like-kind.” However, the definition of like-kind is broader than you may think. Under IRS 1031 exchange rules, properties must be of “the same nature, character, or class” but the “quality or grade” does not matter. Essentially, most real property in the U.S. is like-kind to other real property in the U.S.
This means, for example, that you could exchange acres of farmland for an apartment building, an industrial park for a retail store, or a hotel for a restaurant. However, it’s important to note that some properties do not qualify. Personal property such as a primary residence or a vacation home not used as a rental property does not qualify.
Are There Any Deadlines I Need to be Aware of?
There are two important deadlines you must meet when engaging in a 1031 exchange:
After selling your relinquished property, you have 45 days to identify, in writing, one or more potential replacement properties. Then, you have a total of 180 days from the sale date of the relinquished property to close on at least one of the properties you have identified.
These deadlines are based on calendar days and the IRS rarely grants extensions. If the 45th or 180th day falls on a weekend or holiday, you may need to meet the requirements earlier. The time periods also run concurrently, so if you take the full 45 days to identify your replacement property, you’ll only have an additional 135 days to close.
Who Can Help Me Execute My 1031 Exchange?
Working with professionals who are experienced in 1031 exchanges can help you avoid common mistakes that may lead to having your exchange disqualified. These professionals may include your attorney, a tax professional, or a real estate professional who understands 1031 exchanges. In addition, the IRS requires you to work with a Qualified Intermediary (QI) to facilitate your transaction, hold cash, and make sure you don’t take “constructive receipt” of sale proceeds and trigger a taxable gain.
The team at First Guardian Group is happy to answer all your 1031 exchange questions. We can also help you find the right professionals to help you through the process. Contact us today to schedule a free consultation at 866 398-1031.