In this real estate market it is much easier to sell than buy, which makes it especially difficult to effectively do a 1031 exchange and stay within the 45-day rule of identifying properties. One strategy that many don’t know about is called a reverse 1031 exchange. It allows you to purchase a replacement property first, then sell the property you want to exchange it for afterwards within six months and still defer capital gains taxes! To qualify, you will need to be able to purchase the exchange property without using the proceeds of the first sale and you are out of luck if you cannot close on the first property within six months.
I recently completed a reverse 1031 exchange when I made an investment property swap. I had been searching for the right property for months, and when it finally came along I was able to act quickly to purchase it. The terms of the reverse 1031 exchange allowed me enough time to sell another property to qualify for the tax benefit.
The Basics of a 1031 Exchange
The IRS allows real estate investors to indefinitely delay the payment of capital gains taxes if the property swap is done within a certain period of time. It’s essentially a trade of one property for another. You’ll be paying no tax (or very little) on the sale of your property if your swap meets the requirements of this tax provision.
Benefits of a 1031 Exchange
Real estate investors can build wealth by deferring income tax payments on their investment property profits. There is no limitation on how many times or how frequently you can do 1031 exchanges. This becomes possible if you commit to reinvesting that money into another property that is of the same or greater value (also known as “like-kind”).
As the seller, you must identify the property you plan on purchasing within 45 days of the sale of your property.
The Criteria for “Like-Kind”
Essentially any kind of real estate investment property can qualify as like-kind as long as the replacement property is valued the same or higher than the relinquished property. It may be surprising to learn that even an empty lot could be deemed swappable to a rental property, but it’s true.home
When to Use a Reverse Exchange
As in the case with my recent exchange, a reverse 1031 allows the buyer to purchase the replacement property before selling the property they intend to relinquish. Since the investor is not permitted to own both the relinquished and replacement properties at the same time, a qualified intermediary must temporarily hold title to the new property while finding a buyer for the property designated for sale. The sale must be finalized within 180 days to defer the gain into the newly purchased property. This also means that if the property the investor intends to sell is currently earning rental income, the investor can continue to do so for 180 days until the required close-by date.
Resources Needed to Arrange a 1031 Exchange
A 1031 exchange can be a complicated maneuver even for an experienced real estate investor. Keep in mind that the process could result in an additional $5,000 – $7,000 in expenses. Expenses can vary, so as always, it’s best to consult a real estate attorney or a 1031 exchange company. It’s wise to seek guidance from a reputable, full-service 1031 exchange company.
Not all real estate investors may be aware of their eligibility for a reverse 1031 exchange, and successfully pulling it off can be tricky due to the strict guidelines, but done correctly it could maximize your investments. Want to discuss it further? Reach out to me at (401) 848 – 4358 or matt@hoganri.com.
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