A 1031 exchange can be a great investment opportunity for those who want to explore the world of real estate. To summarize very briefly, a 1031 exchange is when an investor trades a property for another. Despite how simple this idea sounds, there are specific rules, monetary considerations, and time-limits that an investor must follow. Here in this article, we have listed seven things to remember when deciding if a 1031 exchange is something you want to delve into further.
#1 – You cannot use 1031 exchange for a personal home
For 1031 exchanges, only investment and business properties can be used in the transaction. An investor is not able to swap their personal home for a different one.
#2 – Other property aside from buildings can qualify for 1031 exchange
The majority of 1031 exchanges include properties such as homes, condos, offices, open land, and more. But, some exchanges can include property that is more personal, such as a painting or other valuables.
#3 – Be aware of what may lead you into trouble
Do take into consideration mortgage loans and debts on the relinquished or replacement property. If you do not acquire a cash return but your liability goes down, then it can be treated as income and thus taxed.
#4 – There are time limits when making deals
The investor must designate a new property within 45 days of closing on the relinquished property. Alongside that, the investor also has 180 days from the closing date to seal the deal on the new property.
#5 – Any cash left over from a 1031 exchange gets taxed
It is possible to have cash left over after your intermediary has obtained the replacement property. If this is the case, then your intermediary must pay it to you after 180 days. This extra cash is referred to as “boot” and can be taxed as sale gain from the property.
#6 – You can designate more than one replacement property
An investor can choose more than a single property as a replacement in the 1031 exchange. However, if the investor does decide to do this, he or she must follow these rules:
- An investor may designate three replacement properties of any value but must have a serious intention to close on one or more.
- An investor may designate more than three replacement properties, but the total value cannot surpass 200% of the traded property market value.
- An investor may designate more than three replacement properties that have a total value over 200% of the traded property. But, the investor has to acquire 95% of the market value for the replacement properties.
#7 – The term “like-kind” in a 1031 exchange is not so literal
Property relinquished in a 1031 exchange must be traded for a replacement property of like-kind. Many may interpret this as meaning the investor must exchange the exact same type of property for another. But, it is actually more flexible than that. For example, an investor can trade a condo for a family home or office space.