Some investors may love when they hear “Section 1031 Exchange.” Others may cringe. A 1031 Exchange can be incredibly valuable to real estate investors, but there is no doubt it’s a little complicated & there is no room for error. So let Latitude Commercial help clear everything up. Join us as we go through what exactly a 1031 Exchange is & why it can be so valuable for you as a real estate investor!
What is the Section 1031 Exchange?
The Section 1031 Exchange is a powerful tax strategy that can be used to improve your investment returns. Commonly referred to as a “Tax Deferred Exchange,” “Starker Exchange,” or “Like-Kind Exchange,” it is a provision within the Internal Revenue Code (IRC) implemented for the purpose of deferring the tax of like-kind real estate for qualifying exchanges. Specifically for the purpose of selling investment property and not your personal residence.
Why is it so valuable?
The 1031 Exchange is incredibly valuable to investment property owners. Within the provision it states that “No gain or loss shall be recognized on the exchange of property…held either for productive use in a trade or business or for investment.” This means you can defer capital gains taxation on the profit and not recapture the depreciation that the property has taken. Using this strategy gives you the opportunity to invest in something that produces regular cash flow instead of an asset like land that, best case, appreciates slowly over time. Another phrase commonly used by investors is being able to “swap till you drop.”
How do you apply the Section 1031 Exchange
Being that the Section 1031 Exchange is so valuable, it has very strict rules. The first step is expressly showing that the property has investment intent with a track record of not being for real property use. Both the property you want to sell and the property you would like to buy must be held for investment, but they don’t have to be for the same usage (like office, industrial, retail shopping, etc.). The next step is the 45-day identification period. After you close the sale you have 45 days to list properties you may intend to purchase. The 45-day deadline is strict & cannot be negotiated. There are three options to identify a list of properties:
- The most common option is to identify up to three specific properties that you would like to exchange with.
- The second most common is the 200% rule. All properties that you identify cannot be valued more than 200% of the property you are looking to sell.
- The least common, but still used, is the 95% rule: Identifying as many properties as you would like, although you must buy 95% of the properties identified.
Once the properties are identified, you are given a strict 180 days to close on the new property. The 180-day exchange timeline rule is crucial, you must close on one or more of the properties from your list. If the 180 days are concluded without closing, the money will be taxed.
As you may be able to tell, there really is no room for error in a Section 1031 exchange. That’s why using qualified intermediaries is vital for this entire 1031 Exchange process. They are essential for processing the paperwork and holding your money from the sale. In fact, the investor is not allowed to touch or receive the money from the transaction since this would be a conflict of interest. A proper third party must be used to transfer these funds in the exchange.
Latitude Commercial provides commercial real estate services such as purchasing, leasing, tenant representation, and property management throughout Northwest Indiana and the Chicago Suburbs. Plus we’re here to help with all of your 1031 Exchanges. To find out how we can help you close on your new investment property, call us today at (219) 864-0200.