1031 Exchanges: What You Don’t Know will Cost You Thousands
Are you thinking of selling your investment property? Cashing out and heading for the hills. According to Los Angeles Almanac, the average home price in Riverside County for 2021 was $586,000. Think about this for a moment, if you sell your investment property for $586,000 and profit $300,000 and don’t reinvest the money within a 1031 exchange, most likely, you will be hit with 33.3 % in taxes (20% capital gains plus 13.3% in CA State taxes). 33.3% of $300K is a WHOPPING $99,990k+ in taxes. Let that sink in for just a moment.
$99K is enough for a down payment on another investment property. Help your kids or grandkids get started in Real Estate by purchasing another property and then gifting it to them upon your passing; this will save them from paying Capital Gains.
For this article, I will discuss the basics of exchanges. Starting with the types of exchanges you may come across.
Types of 1031 Exchanges
1. Simultaneous Exchange
A simultaneous exchange occurs when the property you are selling and the property you are purchasing close escrow on the same day. This type of exchange is also called drop and swap exchange. Before the 1980s, all exchanges were simultaneous.
2. Delayed Exchange
A delayed exchange is the most common exchange. A delayed exchange occurs when you close escrow on the property you are selling but have not identified the property you are buying yet.
You have 45 days to identify the property you’re buying, and then you must close 135 days after that for a total of 180 days from the day you closed escrow on the property you sold.
3. Reverse Exchange
A reverse exchange is very similar to a delayed exchange; however, a reverse exchange is when you acquire the replacement property before selling your current property.
You have 45 days to identify which property you will sell if you own more than one rental property. You must close 135 days after that for a total of 180 days.
4. Improvement Exchange
An improvement/construction exchange allows you to improve the replacement property before the final acquisition, and the stipulations remain the same as a delayed exchange.
Professional Resources for 1031 Exchange
To have a successful, stress-free exchange, it’s essential to have a team of knowledgeable surrounding you. Your team might be comprised of the following:
- CPA
- Qualified Intermediary (QI), like a title company
- Real Estate Agent or Broker
- Financial Advisor (possibly)
- Real Estate Attorney
What are the Requirements for a 1031 Exchange?
Your replacement property needs to be an equal or greater value than the property you are selling. Remember that you must identify the property you are buying within 45 days from the date you sold your current property. And must conclude the entire exchange within 180 days from the date escrow closes on the property you sold.
Q&A Regarding 1031
Q. Can I live in my 1031 Exchange Property?
A. YES, if a property has been acquired through a 1031 Exchange and is later converted into a primary residence, you must hold the property for no less than five years, or the sale will be fully taxable.
Q. What is the cost of an Exchange?
A. Typically, around $1000, and the QI (Qualified Intermediary) can make interest on your money until it goes into the property you’re buying
Q. Can I do an exchange with a family member?
A. This raises RED Flags with the IRS. It can be done, but there are specific rules that must be followed. We recommend against it.
Q. Can I sell one property and buy three more?
A. YES, as long as you meet the requirements of the exchange
Q. Can I sell a Single-Family Home and buy a 4-plex?
A. YES, as it’s considered a like-for-like exchange. (Income property for income property)
Real-Life Example of a 1031 Exchange
Investor sold an office/industrial complex for $2,500,000. The investor used the proceeds to purchase another commercial building and two single-family homes. Since the investor reinvested in other income-producing investment properties, the investor avoided $500,000 in capital gains tax.
Generational Wealth
We have all the resources you need to do a successful exchange and save you hundreds of thousands in capital gain taxes so you can create generational wealth for yourself and your kids and grandkids.
