Benefits of 1031 Exchange
How to Maximize Your Wealth With a 1031 Exchange
A 1031 Exchange (or tax-deferred exchange) allows you to sell investment property and buy new property with the profit from the sale and not owe taxes on it right away. This can be an excellent way to maximize your wealth and diversify your financial portfolio. It is important to note that the intent must be to hold the replacement property as an investment or for productive use in trade or business, not for resale. The exchange structures include simultaneous, delayed, build-to-suit, reverse and reverse build-to-suit.
A profitable strategy
A great strategy for optimizing your 1031 Exchange is to purchase a rental home below market value, rent it for a year, sell it then buy two rental properties with the gain. However, the property you are going to purchase must be “identified” and closed within a certain amount of time. To “identify” a property, you must deliver a signed document to the person assisting you – they cannot be related to you – on or before 45 days from the date you sold the original rental property.
You can identify more than one property as a replacement property but it should not exceed three without regard for fair market value. You can identify as many properties as you want as long as the total value doesn’t exceed 200% of the original property’s value. You must purchase replace property of the same or greater value as the relinquished property. It is also imperative that you reinvest all the exchange equity into the replacement property. It is required that you obtain the same or greater debt on the replacement property as the relinquished property. You don’t have to close on all the properties you identify; however, if at the end of the identification period you have identified more properties than allowed, it’s as if you identified no property at all. You will then owe taxes on the original sale. Once the 45 days have passed, you may not change your property identification list and must purchase one of the listed replacement properties or the exchange fails.
Because of the 95% Exception, if you identify more than three properties, replacement properties must be received by the end of the exchange period and fair market value of at least 95% of the aggregate fair market value as of the date of the transfer of all relinquished properties.
According to the IRS Code Section 1031: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investments.” Like-kind property includes condos, single-family homes, land, apartments, industrial property, retail, duplex and commercial.
Watch your calendar
You have up to 180 days to complete an exchange. Property will not be treated as “like kind” if it is received more than 180 days after the transfer of the property you’re selling. For multiple property transfers, the 45-day identification period and the 180-day exchange period are determined by the earliest day a property was transferred.
Note: The 45- and 180-day rules are calendar days including Saturdays, Sundays and holidays. There are no extensions for the deadline.
It is possible to buy before you sell and still follow the rules of the 1031 Exchange.
Converting your 1031 Exchange to a primary residence
In order to convert a 1031 Exchange property to a primary residence, you must hold the property for five years and live in it for at least two (although you could use it as an investment the first year). However, depreciation will not go away. There is no set time frame for the holding period; however, one year and a day would be two separate tax years.
A profitable benefit of using a 1031 Exchange is the significant tax savings you can receive. It’s a simple process if you know the rules and regulations. We can help you make the best decisions when buying a Telluride Property using a 1031 Exchange, just give us a call.
Please note that all information provided in this article is subject to change by the Internal Revenue Service, so make sure you seek the advice of a qualified professional such as an accountant or attorney when planning your tax-deferred exchange strategy.