A 1031 exchange is an investment strategy that lets investors defer capital gains taxes on the sale of a property. As per the rules, if an investor reinvests entire sale proceeds into another like-kind property, they can defer capital gains tax imposed on the transaction. It is the best strategy if you want to expand your investment without paying taxes. To qualify for a 1031 exchange, investors must abide by some rules laid down by the IRS.
1031 Exchange Rules –
- Like-Kind Property – The first requirement of a 1031 exchange is that both relinquished and replacement properties must be like-kind. For example, if you sold a retail shop or an office space, your new property must also be used for business purposes.
- Qualified Intermediary – Every 1031 exchange investor must hire a Qualified Intermediary (QI) or facilitator. The Qualified Intermediary actively participates in your 1031 exchange and closes the deal on your behalf.
- Identification – After closing on the sale of your relinquished property, you must identify one or more 1031 exchange replacement properties within 45 days. This time-frame is known as the ‘Identification Period.’ Failing at this step can jeopardize your 1031 exchange.
- Equal Debt – Both your relinquished and replacement properties must have the same debt. For example, if the relinquished property had a debt of $200K, debt on the replacement property should also be $200K.
- Exchange Period – You must complete your 1031 exchange within 180 days, which begins the day relinquished property is sold. It includes the identification period.
A 1031 exchange is considered valid only if it complies with these rules. You can choose any investment property as your 1031 exchange investment property. Investments like DSTs or TICs also qualify as 1031 exchange replacement properties.
What qualifies as a 1031 exchange replacement property?
- Retail shops
- Office spaces
- Multi-family apartments
- Triple Net properties
- Industrial properties
- Student housing buildings
- Medical office buildings
- Self Storage properties
- DST Investment
- TIC Investment
Ways to identify 1031 exchange replacement property –
The simplest way is to get out on the street and look for every property that’s on sale. However, this method also requires a lot of effort and time, and yet there is no guarantee that you will find an ideal replacement property. Another way is to visit offices of real estate firms or agents. This will make your job easy. Real estate agents or firms have lists of available 1031 exchange replacement properties, and you can get one such list by paying a small sum of money to them. However, the best way is to speak to a 1031 exchange expert and inform them about your requirements. They can help you locate replacement properties in no time. During the identification period, all you need to take care of the dates and keep your options organized.