How Much Should You Be Paying for a 1031 Exchange? [New Research!]

Check out Dave’s recent article on the cost of 1031 Exchanges on the Bigger Pockets Blog here.

Free Webinar: 1031 Exchange Investor Essentials

Register here for this October 18th webinar from 5:30 p.m. to 6:30 p.m. ET.

Not sure what to make of all the buzz about 1031 Exchanges? Let me introduce you to this powerful section of the IRS tax code and walk you through its legality and benefits.

Confused by what you have heard about all the requirements? Intimidated by the deadlines? I’ll help eliminate the fear factor with clear and concise information.

Think this option doesn’t apply to you? I’ll provide 1031 exchange options for when the replacement property is identified first or requires renovation.

Whether you have 50 properties or are new to real estate investing, I encourage you to join me for one hour and learn how 1031 Exchanges can accelerate your portfolio growth.

Register here for this October 18th webinar from 5:30 p.m. to 6:30 p.m. ET.

Can You Exchange a Hotel for a Restaurant with a 1031?

A 1031 exchange is a useful way for investors to defer capital gains taxes while reinvesting their proceeds. In order to carry out the exchange in a proper manner you will need to make sure that your replacement property is of “like kind.” Seeing that a 1031 exchange is also called a “Like-Kind Exchange,” it is reasonable to assume that it is very important to ensure that the new property is of like kind. But what does like kind mean in regard to a 1031?

Like kind essentially means that the replacement property must be used for investment purposes only. Primary residences do not qualify. A replacement property can be any type of real estate as long as it is being used for investment purposes. You can exchange a hotel for a restaurant. A warehouse for a farm. Even oil and gas interests for a single-family home.

Why do Fix and Flips Not Get Along With 1031 Exchanges?

I have said it before, and I will say it again; a 1031 is all about the intent. A 1031 exchange is designed to help investors exchange investment real estate while deferring capital gains tax. To qualify as investment real estate a property must be held for productive use. Productive use is a rather broad phrase that essentially means “The land must be doing something.” It could be used for renting, appreciation, agriculture, etc. It just has to be clear that the intent of the land is for productive use.

A fix and flip is a property that is bought to be sold. There is no intent to hold the property for productive use. As such it will not qualify for a 1031 until it can be proven that the real estate in question is for more than just selling. If you really want to carry out a 1031, your local tax guru might have a few ideas on how you can demonstrate your intent to hold your property for investment.

Does a Vacation Home Qualify for a 1031 Exchange?

A 1031 exchange is all about intent. In order for real estate to qualify for a 1031 exchange, the property must clearly be for investment purposes. A multifamily home that is being rented out is a clear example of a piece of real estate that is being used for investment purposes. A vacation home that is rented out for people to stay in is another example of an investment property.

But one of the reasons to own a vacation rental is to use it yourself. And family members will certainly be asking you to let them stay for free. Free stays from family members and personal trips to the lake house count as “personal use.” So how do you know when you’ve crossed a line and turned your investment property into a second home. Luckily, the IRS has a clarifying “Safe Harbor” rules. A vacation home qualifies for a 1031 if;

(a) The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange (the “qualifying use period”)

(b)  Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange,

(c)  The taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and

(d) The period of the taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental. For this purpose, the first 12-month period immediately preceding the exchange ends on the day before the exchange takes place (and begins 12 months prior to that day) and the second 12-month period ends on the day before the first 12-month period begins (and begins 12 months prior to that day).

It is always a good idea to check with your local tax expert to ensure that your property meets all the requirements listed above

Can You Exchange One Property into Multiple Properties With a 1031 Exchange?

One of the most powerful aspects of a 1031 is its ability to truly broaden your investing horizons. Rather than simply exchanging one property for another, investors have the potential to diversify and place their tax deferred proceeds into multiple investment properties. Turning one piece of real estate into two or three is not a bad way to start building an investing empire.

It is also good to remember that “like kind” in a 1031 does not mean that the properties you are exchanging have to be exactly the same. You can exchange a residential apartment complex for an industrial warehouse. You are limited only by your imagination and desire to diversify. Though, it is also wise to see what your local tax expert advises.

Keeping The Right Name On The Paper In A 1031 Exchange

A 1031 exchange has very specific title and taxpayer requirements. Whoever the taxpayer was on the old property has to be the taxpayer for the new property. In general terms, it means that if you own a piece of property and sell it via a 1031 exchange, then you have to be the buyer of the new property.

Furthermore, any tax-paying entity that owns real estate can do a 1031 exchange, whether it is a corporation, a partnership, an LLC, a trust, or an individual. Individual members of these tax-paying entities, however, cannot solely carry out a 1031 exchange on a property owned by said organizations. The organization is the taxpayer, not the individual. The deed to a property might be in the name of a single member of an LLC. But, if it has chosen to be taxed as a sole proprietor, then all activity for the property owned by that LLC is reported on the individual (or joint) tax return of the single member. In that event, guess what? — The individual is really the taxpayer for 1031 purposes even though the deed is held by the LLC.

There is an easy rule to help you avoid trouble in all of this: Look at the tax returns and you won’t go wrong!

Choosing Your Qualified Intermediary

5 Things to Look For

Before you can begin your 1031 exchange, you will have to select a Qualified Intermediary (QI). A good QI can make or break your exchange. To ensure that everything goes smoothly it is important to make sure that your Qualified Intermediary is actually qualified. Here are four things to look for in a QI.

1.   They should use a segregated, qualified escrow account (at no charge)

Make sure that the QI you select does not have a pooled exchange account. It is important to ensure that your exchange account is not comingled with someone else’s funds. Your QI should have a segregated qualified escrow account so that only your money is in that account and it is identifiable to you.

2.   They must guarantee their exchange

Your Qualified Intermediary should do everything in their power to ensure that your exchange is successful. A good QI should be able to assure you that your exchange will be carried out without a hitch.

3.   Audit protection – providing support and documentation if needed (at no charge)

Make sure that the QI you select keeps their records and documents tidy. Should an audit occur, you want to be certain that your QI has all the documentation you need.

4.   They must be easily accessible to answer questions (at no charge)

Avoid Qualified Intermediaries with poor communication skills. You want your QI to be reachable and ready to answer any questions that you might have.

5.   Experience

You want to look for a QI who has experience, a reputation in the industry, and who has demonstrable results. Do not select a Qualified Intermediary who does not have a history to back up their claims.

Selecting a good QI is one of the most important steps to ensure that your 1031 goes as planned. If you select the right QI to guide you through the process, the rest of your exchange will run much more smoothly.

To learn more about how you can utilize the power of a 1031 Exchange visit The 1031 Investor

6 Requirements for Carrying Out a 1031 Exchange

If you want to carry out a successful 1031 exchange, there are six requirements you will need to fulfill. All six must be met for your exchange to be recognized by the IRS. Here is a helpful little summary to get you started.

1.   The Intent to Hold for Investment

Your primary residence cannot be exchanged with a 1031. But any real estate that is demonstrably being held for business, investment, or productive use in a trade can be exchanged.

2.   45-Day Identification Rule

From the day you close the sale on your old property, you have 45 days to identify a replacement property or properties. You must compile a legible list of your selected properties for the IRS. At the end of the 45-day period, the houses on your list are final and no more changes can be made.

3.   180-Day Exchange Period Rule

From the closing on the sale of your old property, you only have 180 days to complete the whole exchange. Or until your next required tax filing, whichever comes first. Make sure you time your exchange carefully.

4.   Qualified Intermediary (QI) Requirements

Finding a QI is vital to the success of your 1031. You must find a QI before selling your old property. If you sell your property before you find a Qualified Intermediary, then you cannot exchange that property using a 1031.

5.   Title/Taxpayer Requirements

The person who pays the taxes before the exchange must pay the taxes after the exchange. If a married couple jointly holds title to the old property, they must both hold the title jointly on the new property as well.

6.   Reinvestment Requirements

If you wish to defer all taxes, then you must reinvest all your proceeds. Money that is removed from the exchange becomes taxable to the IRS while the rest remains sheltered in the exchange.

This list should help you get an idea of what it will take to carry out a 1031. With an experienced Qualified Intermediary and respect for the rules, your 1031 should go smoothly.

To learn more about how you can utilize the power of a 1031 Exchange visit The 1031 Investor.

What Happens If I Can’t Complete My 1031 Exchange?

A 1031 is a great low risk method for deferring capital gains tax. But what happens if you can’t complete your 1031 exchange? Long story short; as soon as your 1031 falls through your sale becomes a taxable event to the IRS. An exchange can collapse for several reasons; failing to identify a replacement property during the 45-day period, failing to purchase a property off your 45-day list by the end of the 180-day period, and failing to complete the exchange before your next tax return. If you bought every property on your list and still have money left over, those funds become taxable to the IRS while the rest is sheltered in the exchange.

Sometimes life just happens and you can’t complete your 1031 exchange. You can’t find the right property, or the property you want falls through, or you’re handed one of those “uh-oh” moments. Fortunately, there is no penalty for starting a 1031 exchange and not completing it, other than paying the tax that would have normally been due. The 1031 exchange can be an inexpensive way to “kick the can down the road” to see what might be available. And while there are no repercussions for not completing a 1031, completing a successful exchange will help you maximize your real estate investing.

To learn more about how you can utilize the power of a 1031 Exchange visit The 1031 Investor.