What Is A 1031 Exchange In Plain English?
1:51 AM
Many people have no idea what a 1031 exchange is, but hear of it when it comes time to sell off property. This article is intended for those people. I have written this in the simplest way that I can so that it can be understood by all.
It is important to understand the purpose behind a 1031 exchange in order to understand it. The point of using 1031 exchange is to defer the immediate taxes on the proceeds gained from the sale of property. This can be done legally if you plan to immediately reinvest those proceeds into another piece of property. The reason you would want to do this is so that you do not lose any portion of the equity you have built up in a property simply because you essentially exchanged one property for another.
So now that you understand the purpose, you should understand a little bit about how it works. First, you are required by law to have what is called a QI. This is a 3rd party that is independent and serves as a Qualified Intermediary (hence QI). They are there to hold the profits from the sale of the first property that you sale until you invest it into another property(s).
There are certain things that will qualify and what will not qualify for a 1031 exchange. 1031 exchanges involve the sell and purchase of property. Most typically, this refers to property like single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are specific exclusions from 1031 exchanges, such as stocks and bonds. You should ask your QI about other exclusions before making any decisions on a 1031 exchange.
Second, the move from one property to another has to be of like kind. This does not refer to the condition or value of the properties, but rather that they are similar in character or nature. They (referring to all properties involved) must also be held for productive use in trade or business or held for investment purposes.
The 1031 in 1031 exchanges actually comes of the Internal Service Revenue code. Keep that in mind because there are a lot of rules and regulations about how you can and cannot use a 1031 exchange. While it is always advisable to seek the guidance of a professional pertaining to your circumstances, there are some general guidelines that can help you understand the basics.
1- The value of the replacement property must be equal to or greater than the value than the old property that you are selling. 2- The equity of the replacement property must also be equal to or greater than the value of the old property that you are selling. 3- The debt on the replacement property must be equal to or greater than the debt of the old property that you are selling. 4- ALL of the net proceeds from the old property that you are selling must be used to acquire the replacement property.
There are also some strict timeline guides related to 1031 exchanges. First, the investor must identify the new property within 45 calendar days of the close of the old property. (There are some guidelines about how you identify, but that is a later discussion) Second, the investor must close on the new property within 180 calendar days from the closing date on the old property. I hope that this has helped you understand, in plain English, what a 1031 exchange is. There is a lot more information out there on it and you should consult a professional if/when you get serious about doing this.
It is important to understand the purpose behind a 1031 exchange in order to understand it. The point of using 1031 exchange is to defer the immediate taxes on the proceeds gained from the sale of property. This can be done legally if you plan to immediately reinvest those proceeds into another piece of property. The reason you would want to do this is so that you do not lose any portion of the equity you have built up in a property simply because you essentially exchanged one property for another.
So now that you understand the purpose, you should understand a little bit about how it works. First, you are required by law to have what is called a QI. This is a 3rd party that is independent and serves as a Qualified Intermediary (hence QI). They are there to hold the profits from the sale of the first property that you sale until you invest it into another property(s).
There are certain things that will qualify and what will not qualify for a 1031 exchange. 1031 exchanges involve the sell and purchase of property. Most typically, this refers to property like single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are specific exclusions from 1031 exchanges, such as stocks and bonds. You should ask your QI about other exclusions before making any decisions on a 1031 exchange.
Second, the move from one property to another has to be of like kind. This does not refer to the condition or value of the properties, but rather that they are similar in character or nature. They (referring to all properties involved) must also be held for productive use in trade or business or held for investment purposes.
The 1031 in 1031 exchanges actually comes of the Internal Service Revenue code. Keep that in mind because there are a lot of rules and regulations about how you can and cannot use a 1031 exchange. While it is always advisable to seek the guidance of a professional pertaining to your circumstances, there are some general guidelines that can help you understand the basics.
1- The value of the replacement property must be equal to or greater than the value than the old property that you are selling. 2- The equity of the replacement property must also be equal to or greater than the value of the old property that you are selling. 3- The debt on the replacement property must be equal to or greater than the debt of the old property that you are selling. 4- ALL of the net proceeds from the old property that you are selling must be used to acquire the replacement property.
There are also some strict timeline guides related to 1031 exchanges. First, the investor must identify the new property within 45 calendar days of the close of the old property. (There are some guidelines about how you identify, but that is a later discussion) Second, the investor must close on the new property within 180 calendar days from the closing date on the old property. I hope that this has helped you understand, in plain English, what a 1031 exchange is. There is a lot more information out there on it and you should consult a professional if/when you get serious about doing this.
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As you search around for more information on a 1031 exchange, remember that some people also call it a 1031 Tax Exchange. Always remember to aska Qualified Intermediary before making any decisions.
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