A 1031 Exchange is also referred to as a "like kind exchange". It is basically a tax deferred exchange for selling one qualified property and then acquiring another qualified property within a specific time frame. The time frame is critical in 1031 Exchanges. So if you are selling a property, you want to make sure you notify your real estate agent that you want to consider a 1031 Exchange at the time you list the property. This will ensure your agent is aware of your desire for a 1031 Exchange and keeps a close watch on the timeframes in order to ensure you do not miss them. Because if you miss one deadline, even by a day, you are not able to do a 1031 Exchange. So timing is critical!
Why do a 1031 Exchange?
- Any real estate investor or property owner should at least consider a 1031 exchange when he/she expects to purchase a replacement "like kind" property. Any other transaction would necessitate the payment of capital gains tax, currently 15% and is scheduled to go back to 20% and potentially higher.
- The main objective of a 1031 is the IRS depreciates the capital real estate investments at 3%/year rate as long as you hold the investment or until it is completely depreciated. When you sell a capital asset, the IRS will tax you on the depreciated portion as an income tax, which would be at the marginal tax rate.
- EXAMPLE: If you have an investment property that you have held for 15 years, the IRS will depreciate it 45%. The IRS will then want you to pay the taxes on the 45% depreciation. If combined state and federal states are 35% at a marginal rate, that’s about 15% of the cost of the property or 1/3 of 45%.
If your property is fully depreciated, it becomes the whole 35% marginal tax rate.
Two Major Guidelines of a 1031 Exchange:
- Total Purchase Price of the replacement property ("like kind") must be EQUAL to or GREATER than the total net sales price of the property being sold.
- ALL equity received from the sale of the property HAVE to be used to acquire the replacement ("like kind") property or properties.
- NOTE: You can purchase more than one property and up to three properties as long as the two major guidelines above are met and the timeframes for the 1031 Exchange are upheld.
NOTE: You can purchase more than one property and up to three properties as long as the two major guidelines above are met and the timeframes for the 1031 Exchange are upheld.
There are many other aspects to a 1031 Exchange and a 1031 Reverse Exchange. Sometimes a 1031 Exchange is not the best option for an investor or property owner, please contact us to discuss if a 1031 Exchange is a smart investment move for you.