August Real Estate Tip - The Power of the 1031-Exchange
Every property owner, present and future, should know of a VERY powerful tool to create wealth and restructuring of portfolios - the 1031 Tax Deferred Exchange. This is a highly recommended option, for a variety of reasons, but before we discuss those reasons, let’s define this tool.
What is a 1031 Exchange
A 1031 Tax Deferred Exchange allows the owner of investment property to sell that property and buy a like-kind property while deferring capital gains tax that would normally be incurred on a sale.
A 1031 Exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows you to avoid paying capital gains taxes when you sell an investment property, and instead reinvest the proceeds from the sale, within certain time limits, into a property or properties of like-kind and of equal or greater value. As in most things, there are rules and requirements for a property to qualify as a successful exchange.
Reasons to Consider an Exchange
You may be seeking a property that has better returns or may wish to diversify asset classes (apartments to industrial, industrial to office, land to retail, etc.) Other considerations include:
Assist in retirement plans or management plans
Reset the deprecation (more on this in another article)
To “trade up” to increase portfolio size and subsequent cash flow opportunities
The “RULES” of an Exchange
The property or properties being exchanged into must be of equal or greater value than the relinquished property.
The three-property rule allows you to identify three properties as potential purchases regardless of their market value.
The 200% rule allows you to identify unlimited replacement properties so long as their cumulative value doesn’t exceed 200% of the value of the property sold
The 95% rule allows you to identify as many properties as you like so long as you acquire properties valued at 95% of their total or more
Typical Timeline for an Exchange
You must identify the properties under the rules outlined above within 45 days of the closing of the relinquished property
The closing on the exchange and new property must take place within 180 days of the sale of the relinquished property
While this is a quick overview of the process associated with a 1031 Exchange, there is a vast amount of other considerations when determining your options with regards to conducting an exchange or not. I strongly recommend all considerations for an exchange be weighed out with your attorney, CPA, and a trusted real estate broker that specializes in investment property brokerage.
Please feel free to reach out to Kevin Fletcher, CCIM with any questions you may have via email, kevin@maineccim.com.
Written by Kevin Fletcher, CCIM, Associate Broker and President of The Fletcher Group.