1031 Exchange: Explained and Answered for the Everyday Property Owner

Tax graphs on a computer

Tax graphs on a computerLawyers and accountants may have tried to explain the 1031 exchange in simpler words, but understanding what 1031 exchange is, with all the legal and accounting jargon, can be confusing to the everyday business owner.

So, here are some of the basic questions about the 1031 exchange answered to make your future investments more understandable.

What is the 1031 Exchange?

When you sell your property, the Internal Revenue Service (IRS) takes a chunk of the profit as “capital gains tax,” which may be a problem if you were planning to use that profit to buy another property. According to 1031ex.com, property investors should never have to pay for taxes if they plan to reinvest that income immediately in a similar type of property.

This is where the 1031 exchange comes in. In its simplest form, it means that if you sell your property and purchase another “like-kind” property, you do not have to pay taxes.

What does “like-kind” mean?

“Like-kind” properties mean that the property you are selling and the property you are buying must be of the same nature, character, or class. The quality or grade doesn’t matter.

Words like “character” and “quality” may sound alike, but there’s a difference, according to the IRS. For example, you can trade a run-down apartment building for a brand new home you plan to rent out, which has equal value to the building you sold.

How Do I Find the Right Property?

If you don’t have a property to purchase after selling your old property, you need a middleman called “qualified intermediary” or “exchange partner.” This is an independent third party who holds the money made from selling your old property. You can’t touch that money, but you have 45 days to find a property to buy and then another 180 days to make the purchase.

It is recommended that you find the property you want to purchase before selling your property, but sometimes this is not possible due to time restraints. Some exchange partners offer replacement property search assistance to help you find the property you need.

Can I Sell My Residential Property?

Unfortunately, you cannot use the 1031 exchange for personal purposes. There are some loopholes regarding vacation homes you once used and now rent, but there are strict guidelines to prevent abusing the 1031 exchange. For trickier properties like this, it is best to have a CPA Attorney with you.

The 1031 exchange may sound daunting, but it’s an important strategy for property owners and investors looking to diversify their portfolio or earn passive income. To be prepared, however, it is best to have a lawyer during this exchange. This is a smart decision if you want to sell your property in exchange for another.