“1031 Exchange” is a nickname coined from Section 1031 of the U.S. Internal Revenue Service Tax Code. A 1031 Exchange offers investors an incredible way to make significant tax savings.
When selling your Idaho investment property, the combined state and federal taxes can amount to as much as 30% of the sales cost. A 1031 Exchange can help you defer the payment of such taxes and theoretically there is no limit to how many deferments you can make.
This means that you may be able to defer payment on the sale of investment properties an infinite number of times. Without a doubt, a 1031 Exchange is a great investment strategy for savvy investors.
The following is a guide to the 1031 Exchange in the state of Idaho.
Why is it Called an Exchange?
It’s exactly what it sounds like because you’ll need to exchange one property for another. Both the properties must be like-kind, however, in a 1031 Exchange, like-kind doesn’t take a literal meaning.
The term is relatively broad, and in real estate, like-mind means the two properties being exchanged must be similar in both nature and character. And the properties being swapped for one another must be in the United States.
Examples of properties that may qualify as like-kind include:
- Shopping center being exchanged for an office building
- A farm being changed for raw land
- An industrial building being exchanged for a shopping center
You can swap these pieces of real estate for one another. However, the same cannot be said of the following properties:
- Your personal residence
- Second homes
- A fix-and-flip property
- Land meant for resale
A 1031 Exchange requires that the properties being exchanged be used for business or investment purposes.
Is there a Deadline for the Exchanges?
Although you may be able to make thousands in tax savings, 1031 Exchanges need to occur under certain deadlines. Missing these deadlines will mean the exchange will not go through.
Selling Your Property
The first process in a 1031 Exchange begins with the selling of a property. All the proceeds you get from the sale then go to a qualified intermediary. The qualified intermediary will then hold onto the funds until the transfer is successfully made to the seller.
From the time you make the sale, you’ll have up to 45 days to identify up to 3 replacement properties. While this may look easy, it’s not always the case – especially if the market isn’t a buyer’s one.
Closing on the Replacement Property
Once you choose the replacement property, the next step would be to close on it. You’ll have two options here,
- You may choose to close by the due date of your next tax returns for the year of the original sale.
- The other option is to conclude purchasing the property within 180 days after selling your property. This option is perhaps the most popular.
For example, say you sold your property on March 1st. Then, you’ll have up to the mid of the next month, April 1st, to identify up to 3 properties to exchange it with.
After the sale, March 1st, you’ll have up to August 27th (180 days) of the same year to close on the property.
Are there Different Types of Exchanges?
There are three ways in which one can conduct a 1031 Exchange. They are as follows:
- A Delayed 1031 Exchange. This is the most common 1031 Exchange type. Before this was enacted, exchanges had to be done simultaneously. But bringing both buyers and sellers to the closing table at the same time led to some problems and potential last-minute conflicts. So, section 1031 of the Internal Revenue Code was changed to allow for exchanges to occur within a 180-day period.
- Reverse 1031 Exchange. Here, you’ll need to acquire the replacement property before relinquishing the one you currently have. So technically, you’ll be owning two properties at the same time – the one you own and the one you have just acquired.
- Build-to-suit 1031 Exchange. This one usually occurs in situations where the replacement property is a new construction or is being renovated. The same 180-day time window will still apply.
What are the Requirements for a Successful 1031 Exchange?
Section 1031 of the Internal Revenue Code stipulates various requirements that must be met for successful tax deferments on capital gains. Some of the requirements are as follows:
- First and foremost, both properties must qualify for the 1031 Exchange. As already mentioned, both properties must be like-kind and must be used for invest
- ment or business purposes.
- The name on the title being relinquished and the tax return must be like those on the buying documents for the replacement property. The only exception to this is if you choose to use a single-member limited liability company (SMLLC).
- The exchange must meet the deadline set in Section 1031 of the IRC. An exchange must be done within 180 days after the successful closing of the first property.
- For the capital gains to be deferred 100%, the net sales price of the relinquished property must be equal to or higher than that of the replacement property. Otherwise, any boot arising may be subject to a capital gains tax.
What is Boot in 1031 Exchanges?
This refers to property that’s non-like-kind in an exchange. It can take different forms, for example, it can be cash, debt relief, or an installment note. While the existence of boot doesn’t invalidate a 1031 Exchange, it leads to a partial exchange.
Takeaway:
1031 Exchanges are a great way for investors to defer payment of tax on capital gains they make after selling an investment property. And best of all, you can do so an unlimited number of times. Consequently, you may be able to create significant wealth over time.
For more information, be sure to check out Realty Management Associates, Inc.