Executing a 1031 exchange tax deferral allows real estate investors to completely defer all of their capital gains taxes after selling an investment property. It is a golden gem that many tax lawyers recommend but few has the diligence to perform.
What exactly is a 1031 exchange tax deferral and how can you perform one?
It’s a tax loophole put in place by the U.S. government to help investors scale the size of their housing portfolios by saving them thousands on taxes when selling. It eventually leads to more tax money for them while providing more housing for their citizens.
The IRS sets rules in place to complete a 1031 exchange properly. President Donald Trump's new proposed tax plan may change these laws and also change real estate investing, which we've covered on our blog as well.
Your new purchase needs to be an investment Property. Both the property you are selling and property you are buying must be for investment purposes. You cannot perform a 1031 exchange on your own home.
After selling your property you have 45 days to identify up to three potential properties you might exchange the original for. These properties will be research by your qualified intermediary, which we will talk about later.
You’ll next have 180 days to close on one of the properties that you’ve identified. During this process you must give a list of your properties to a qualified intermediary, and allow them to handle all of the money throughout the transaction. You are NOT ALLOWED to handle any funds associated with the exchange or it could be invalidated.
That part is where a lot of error happens. IRS Section 1031 specifies that your parents, children, or siblings can be your middle person. It prohibits anyone regarded as your "agent" such as your attorney, broker, CPA or real estate agent from serving as your QI, unless this person has not represented you within the past two years.
After you’ve found a qualified intermediary, make sure the property you are selling and buying are under your name, or under the name that is selling and buying.
The property you are exchanging the original for also must be of equal or greater value of the original
For example, if you just sold your $1,000,000 home, you need to purchase another $1,000,000 home or a home of higher value for the exchange to be valid.
The 1031 exchange is one of the most powerful deferral strategies at your disposal as a real estate investor. We also wrote a FREE downloadable guide on how you can craft a strategic tax plan for your real estate investing strategy.