Brought to you by 1031 Real Estate Exchange Specialist
You may find yourself confused about 1031 exchanges in general. That’s why we have experts on the line, one call away.
We are here to answer your exchange questions and provide you with information and honest feedback on whether you should do one.
What is a Forward 1031 Exchange?
In short, a forward 1031 exchange is a type of like-kind exchange under Section 1031 of the Internal Revenue Code that allows investors to defer capital gains taxes on the sale of investment property by reinvesting the proceeds into a new investment property. Like-kind exchanges are a way for investors to sell one property and acquire a new one without incurring tax liability on the sale of the first property.
An investor will do a 1031 exchange to Defer Capital Gains Taxes.
In a forward 1031 exchange, the investor will first sell their relinquished property. The proceeds for this property must be held in a Trust or Escrow account by a Qualified Intermediary, also known as QI – such as 1031 Real Estate Exchange Specialist.
1031 Exchange Timeline and Deadlines
Upon sale of the investment property is when the investor must begin to keep track of their timeline. An investor will have 45 days from the sale of their relinquished property to identify up to 3 replacement properties or 4+, given the appropriate rules are followed. It is not necessary to purchase every property identified, but it is important that the properties the investor purchases are written on the 45 day letter.
An investor must then, in order to successfully complete a 1031 exchange, reinvest the proceeds from the sale of their relinquished property into the purchase of a replacement property, or multiple properties. The investor must complete the purchase, meaning closing, on every replacement property before the 180 days are up.
IRS Form 8824
It’s important to take into careful account your timeline, as on IRS Form 8824, the form submitted to the IRS to actually file your 1031 exchange, you will need to report a few things, such as:
- A description of the relinquished property
- A description of the replacement property
- The date your relinquished property was acquired
- The date of sale of the relinquished property
- The sale price of the relinquished property
- The date you send a 45 day letter to your QI
- The date you purchased the replacement property
What is Boot?
In a 1031 exchange, the investors goal is to defer taxes. One of the simplest ways to ensure that taxes are fully deferred is to buy a replacement property of higher value than the relinquished property.
In a 1031 exchange, “boot” refers to any property or cash that is received in addition to the like-kind property being exchanged. Boot is considered a taxable event and is subject to capital gains taxes.
For example, if an investor sells a rental property for $300,000 and uses $290,000 of the proceeds to purchase a new rental property, the remaining $10,000 would be considered boot and would be subject to capital gains taxes.
This goes to say, any amount of money withdrawn from the trust account held with your QI is considered realized capital gains and will be taxed as such.
In order to avoid or minimize the amount of boot received in a 1031 exchange, investors can structure the exchange in a way that the values of the properties being exchanged are as close to equal as possible. Additionally, investors can use cash or debt to pay for any remaining difference, rather than receiving cash as boot.
The Benefits of a Forward Exchange
There are several benefits to using a forward 1031 exchange, including the ability to defer capital gains taxes, the ability to leverage equity from the relinquished property to purchase a more expensive replacement property, and the ability to diversify one’s investment portfolio. However, it is important to carefully plan and execute a forward 1031 exchange to ensure that it meets the requirements of the Internal Revenue Code and to avoid potential tax pitfalls.
To qualify for a forward 1031 exchange, the investor must meet certain requirements, including:
- The relinquished and replacement properties must be held for investment or use in a trade or business.
- The properties must be of “like-kind,” which means that they must be similar in nature or character, even if they are not the same in type or quality.
- An investor must not be too concerned with like-kind in real property, as most investment property will qualify as like-kind. If you want to know if you qualify, call us today!
- The investor must engage the services of a qualified intermediary to hold the proceeds from the sale of the relinquished property until they are reinvested into the replacement property.
- The exchange must be completed within the required time frame (45 & 180 Day timeline).
By following these guidelines, investors can take advantage of the benefits of a forward 1031 exchange and defer capital gains taxes on the sale of investment property.
If you’re ready to start the process of a 1031, call or email us to get started today. Its important you let your QI know about your exchange as soon as possible.