The 1031 exchange, also known as a tax-deferred exchange or like-kind exchange, suffered many alterations since its creation in the 1920s, which changed the requirements and the process itself. The transaction practically consists in swapping two similar properties, thus including limited tax or no tax at all. In fact, this perfectly explains the great popularity of the 1031 exchange among real estate investors. Those who intend to conduct such an advantageous exchange must be familiar at least with the basic terms like qualified intermediary, also called accommodator or facilitator, because it holds the funds and eases necessary documentation for the transaction, relinquished property, which refers to the asset sold by the taxpayer and replacement property, which is the asset bought by the taxpayer. Identification period and exchanged period, like-kind property that includes everything from residential rentals and retail stores to commercial property and bare land but also exchange period represent other concepts that every person attempting the 1031 exchange must understand.
How to conduct a 1031 tax-deferred exchange
Of course, mastering a few terms does not actually mean that you are capable of properly conducting such a transaction. You have to become familiar with the guidelines and timelines in order to make sure that you defer taxes in a legal manner. Starting with the basics, the 1031 exchange involves various steps, namely selling the investment property, handing out the capital gains to the facilitator mentioned above, searching for a similar property adequate for the exchange in 45 days, agreeing on a fair price after negotiating with the seller of the specific property, contacting the qualified intermediary again to give him the permission to wire the profit or capital gains to the title company or holder and lastly, completing an IRS form. Real estate investors but also business owners can choose to conduct a 1031 like-kind exchange in order to save approximately 40% of the profits earned after swapping the two similar properties. Of course, before making the actual transaction, the person planning to find a like-kind property has to evaluate that property in order to determine if it meets the conditions.
Requirements to consider before approaching such an exchange
What real estate investors and business owners need to understand is that this smart method does not keep them away from taxes forever. In fact, the moment they decide to sell the new property, the law forces them to focus on that capital gains tax. Of course, paying such a tax is out of the question if you decide to never sell the property. If you have the necessary funds, you can invest in it after finding it a purpose and use it to make even more profit in the future. Another thing that all people thinking about a 1031 exchange must keep in mind is that you cannot give for sale your home or primary residence and purchase in exchange for an investment property. Both the relinquished property and the replacement property must be used for business purposes or investment. This represents an important requirement that taxpayers cannot overlook.