RealtyMogul Answers Some of the Most Frequently Asked Questions About 1031 Exchanges
From start to finish, 1031 exchanges are complex transactions. There are rules, deadlines, property restrictions, and convoluted terminology to navigate.
That’s why we rounded up a few of the most frequently asked questions (FAQs) about 1031 exchanges to help start you down the right path on the road to real estate success.
1031 exchanges can apply to properties outside of real estate, but these FAQs focus on the details of 1031s related to real estate.
A 1031 exchange is an IRS-authorized exchange of properties without immediate tax liability.
The name “1031 exchange” is short for Section 1031 of the U.S. Internal Revenue Service’s tax code. This section states that if an individual exchanges one investment property for another, they may be able to defer any capital gains or losses made on the sale of the initial property by reinvesting in a similar property.
No. Exchanges done properly mean that capital gains and losses are tax deferred. This means the capital gains are tax-free until the investor takes possession of them. It’s also important to know that taking control of cash or other proceeds before the exchange is complete may make all gains immediately taxable.
You must report an exchange to the IRS and file it with your tax return for the year in which the exchange occurred using Form 8824.
The IRS says:
“Owners of investment and business property, individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties.”
First things first, you must own the property you are selling. And according to the IRS, both properties must be “like-kind.”
“Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.”
It is important not to be fooled by this seemingly clear definition of “like-kind.” It can mean a lot of different things for a lot of different properties.
Yes. The following properties cannot be used in a 1031 exchange: vacation homes that are not used as rental properties, primary residences, and property located in a foreign country.
Yes, there are four different types of 1031 exchanges:
There are a lot of rules to follow to successfully execute a 1031 exchange. Some of the most pertinent include:
Once you identify a property, you need to complete the exchange within 180 days after the sale.
There is no limit to how often or how frequently investors may perform 1031 exchanges.
Yes, these are commonly known as “1031 Accommodators”
It’s important to know whom you are hiring to help facilitate your 1031 exchange. The IRS warns against schemes:
“Taxpayers should be wary of individuals promoting improper use of like-kind exchanges. Typically they are not tax professionals. Sales pitches may encourage taxpayers to exchange non-qualifying vacation or second homes. Many promoters of like-kind exchanges refer to them as ‘tax-free’ exchanges not ‘tax-deferred’ exchanges. Taxpayers may also be advised to claim an exchange despite the fact that they have taken possession of cash proceeds from the sale.”
Think a 1031 exchange may be in your future? Read more about them on our blog: