What are 1031 exchanges?
A 1031 exchange, also known as a like-kind exchange, is a trading of properties, where one property is sold and the profits of that sale are used to purchase another property of similar kind. This kind of exchange allows the property investor to not pay capital gains taxes on the properties.
What are the different types of exchanges?
The four types of like-kind exchanges are simultaneous, delayed, reverse, and construction/improvement. In a simultaneous exchange, closings on both properties happen at the same time. Meanwhile, in a delayed exchange the investor sells the initial property before acquiring a replacement property, and a reverse exchange is just the opposite. An improvement exchange means that the profits from the exchange can be used to renovate the replacement property.
What deadlines are involved in a 1031 exchange?
The seller completing a 1031 exchange must narrow down their choices of replacement properties in the first 45 days after selling their original property. The seller will give their list of potential properties to the exchange company, then they need to choose one to purchase within 180 days of the initial sale.
What restrictions are there in a 1031 exchange?
In a 1031 exchange, the seller cannot have access to the proceeds of the initial sale. The g(6) restriction states that profits from the sale will go directly to the exchange company and from there will be used for the purchase of the replacement property.
Can related parties be involved in a 1031 exchange?
Related parties can be involved in the sale of the relinquished property, but related persons cannot be involved in the purchase of the replacement property.
What types of properties qualify to be exchanged?
Assets need to be owned for investment or business purposes in order to be exchanged. Most personal assets are not eligible, like vacation homes. But a single family residence owned as an investment property can be exchanged for any other type of property. Almost all real estate that is owned for business or investment qualify to be like-kind properties.
How do I qualify to defer taxes?
The investor can only defer taxes if they spend all of the cash acquired from the sale of the first house for the purchase of the replacement property. The new mortgage needs to be of equal or greater value than the original property, or else the investor will need to pay taxes. Also, the same person needs to be the owner of both properties to qualify for a like-kind exchange.
Can I pay closing costs with exchange funds?
Exchange funds can be used to pay Normal Transactional Costs, including things like sales commissions, escrow fees, and title insurance fees, but not for any exchange expenses.
Can I exchange one property for multiple?
The number of properties involved in an exchange doesn’t matter, as long as the total price (mortgage, value, equity) is either greater than or equal to the cost of the initial property being exchanged.
How long do I have to own a property before doing an exchange?
There is no specific time period, but instead, the intended purpose for the property must be as an investment or for business.
How much does a like-kind exchange cost?
There is no set price, as the cost varies based on the type and complexity of the exchange. A trading of one property for another could cost $500 dollars, while a reverse swap could cost upwards of $3,000. Before starting an exchange, do your research and find an exchange company that is clear about costs and fees.
Can I refinance to pay off debt before doing an exchange?
You cannot refinance a property before doing an exchange, because it disqualifies the property in question. The whole point of a like-kind exchange is to move the proceeds of one property sale directly into the purchase of another property.
Can I use the profits from an exchange to pay a pre-existing mortgage?
All of the proceeds from the sale of the initial property must be used for the purchase of the replacement property. Any profits used for other purposes are liable to disciplinary action.
Can I cancel an exchange?
You can cancel an exchange, but you need to follow the specific guidelines set by the facilitator of your exchange. The general guidelines state that you can terminate an exchange any time before the closing on the initial property, or after 180 days if you haven’t purchased a replacement property.
What documents do I need to complete the exchange?
For a valid exchange, an Exchange Agreement, assignment of rights, notices to the buyer and seller, and a list of potential replacement properties are all required.
Why do I need a qualified intermediary?
A qualified intermediary is basically a middleman that makes the exchange possible. This way, the properties pass between the intermediary instead of between the buyer and seller, to ensure that the exchange is fair and not just for profit. Without an intermediary you cannot qualify for tax deferment.
Why are there notification requirements?
Once the exchange is complete and the properties are transferred to the taxpayer, formal, written notifications are sent out to all parties involved, to officially state and make a record of the fact that the exchange took place and is complete.
Are there state laws that could affect my exchange?
Most states simply require that your intermediary be licensed and meets state requirements. However, there are a few states with more specific laws. California, for instance, requires that a fee be paid to the tax board if there is any money left over in the exchange account. Also, if you are exchanging properties across state lines, you should make sure to research the requirements in both states. Usually it is not a big deal, but some states may require you to pay back taxes if you sell the replacement property from the initial exchange that you deferred taxes on the first time.
Do I have to pay real estate transfer taxes?
There are no transfer taxes in a 1031 exchange, because the properties go from buyer to seller and vice versa through and intermediary, but on paper it is a direct exchange of properties. Therefore, no transfer tax is required.
Who pays sales taxes?
Sales tax on the property being sold transfer from the buyer to the seller, while sales tax on the placement property can be paid using the profits from the sale if approved.