What is a 1031 Exchange?

A 1031 exchange, also known as a like-kind exchange, is a tax deferral strategy used in real estate investments. It allows investors to sell an investment property and defer paying capital gains taxes on the sale by using the proceeds to purchase a similar investment property. Here are ten key points to know about 1031 exchanges:

1. Eligible Properties: To qualify for a 1031 exchange, the properties being sold and purchased must be considered "like-kind." This means they must be used for business or investment purposes and be of the same nature or character, regardless of their grade or quality.

2. Time Limitations: The taxpayer must identify a replacement property within 45 days of the sale of the original property and must close on the purchase of the replacement property within 180 days of the sale or by the due date of the taxpayer's tax return for the year of the sale, whichever is earlier.

3. Replacement Property Requirements: To defer all capital gains taxes, the taxpayer must acquire a replacement property that is equal or greater in value to the property being sold. Additionally, the taxpayer must acquire the replacement property for the same or greater amount of debt as the property being sold.

4. Qualified Intermediary: A qualified intermediary must be used to facilitate the 1031 exchange. The intermediary holds the proceeds from the sale of the original property until they are used to purchase the replacement property.

5. Tax Deferral: A 1031 exchange allows the taxpayer to defer paying capital gains taxes on the sale of the original property until the replacement property is sold. This can result in significant tax savings over time.

6. Maximum Deferral: There is no limit to the number of times a taxpayer can defer paying capital gains taxes through a 1031 exchange. However, capital gains taxes will eventually have to be paid, either when the replacement property is sold or upon the death of the taxpayer.

7. Cost Basis: The cost basis of the replacement property is equal to the cost basis of the original property, plus any additional expenses incurred during the exchange process, such as closing costs and improvement expenses.

8. Depreciation Recapture: If the original property was depreciated for tax purposes, the taxpayer may be required to pay depreciation recapture tax when the replacement property is sold.

9. Personal Use: If the replacement property is used for personal purposes for more than 14 days or 10% of the rental days in a year, it may result in the disqualification of the 1031 exchange and the taxpayer will be required to pay capital gains taxes on the sale of the original property.

10. Consult a Professional: 1031 exchanges can be complex and it is recommended that taxpayers consult with a tax professional to ensure they are in compliance with all rules and regulations.

In conclusion, a 1031 exchange can be a valuable tool for real estate investors looking to defer paying capital gains taxes on the sale of an investment property. However, it is important to understand the rules and regulations and to work with a qualified professional to ensure a successful exchange.

We at Guardian specialize in the identification and acquisition of net lease properties for our clients who wish to defer taxes through a 1031 exchange. With decades of collective experience in banking, finance, and commercial real estate, our team is best equipped to help you with your 1031 exchange.

Whether it’s your first purchase or your tenth, we are here to help you maximize risk-adjusted returns. Call us at (949) 396-6200 to learn more about how we can help you secure passive income for you and your family.