For those who don’t understand what a 1031 exchange is, but have heard of it and would like to know what it is, now is your chance. Also, I will do my best to explain it in very simple terms so that regardless of your background, you can understand it and how you can benefit from it.
First, to understand what a 1031 exchange is, you need to understand the purpose behind it. The whole concept behind a 1031 exchange is to defer some taxes (capital gains tax) from the sale of that property, when you plan to invest the proceeds from that sale directly into another property. People do this so they don’t lose equity in the transition from one property to another.
So now that you understand the purpose, you need to understand a bit about how it works. First, you are required by law to have what is called a QI. This is a third party that is independent and serves as a Qualified Intermediary (hence QI). They are there to retain the proceeds from the sale of the first property you sell until you invest it in other property(s).
Below are some rules about what can and cannot qualify for a 1031 exchange. First, remember that we are talking about property. This cannot be done with anything other than investment property. However, that can be broadly defined to refer to single-family rental units, multi-family rental units, office buildings, storage facilities, vacant land, retail shopping centers, and industrial facilities.
Second, the transfer from one property to another has to be of the same type. This does not refer to the condition or value of the properties, but rather that they are similar in character or nature. They (referring to all properties involved) must also be held for productive use in trade or business or held for investment purposes.
There are many other specific rules that the IRS has for this type of exchange and that is probably why they require anyone doing this to use a qualified professional trained in this. However, there are some general guidelines that you should be able to understand that can help guide you in your decisions about your investment plans if you are researching this.
1- The value of the new property must be of equal or greater value than the one you are selling.
2- The equity of the new property must also be of equal or greater value than the one being sold.
3- The debt of the new property must be equal to or greater than the debt of the property you are selling.
4- ALL net proceeds from the property you are selling must be used to purchase the new property.
There are also some strict timeline guidelines related to 1031 exchanges. First, the investor must identify the new property within 45 calendar days of the old property closing. (There are some guidelines on how to identify, but that’s a later discussion) Second, the investor must close on the new property within 180 calendar days from the closing date on the old property. I hope this has helped you understand, in plain language, what a 1031 exchange is. There is much more information available about it and you should consult a professional if/when you are serious about doing this.
