1031 Exchange Explained

As the great Benjamin Franklin said: “nothing is certain except death and taxes.”

Let’s be honest, Taxes Suck.

You work 40, maybe even 50 or 60 hours a week, earn your income, then Uncle Sam comes and takes a chunk of what YOU earned and takes it for the US Government.

Imagine you pay for 100% of a pizza, but only get to eat a portion of it because your friends came and stole a piece of the pie. (literally.) This would bug you, and it certainly bugs taxpayers every year when they see how much they are giving away in taxes.

Today, I want to focus on the 1031 Exchange, an amazing tax strategy used when real estate investments are sold, allowing the seller to defer paying capital gains taxes. I want to preface, as i always do, that i am not a professional 1031 expert, nor do I consider myself one, and i strongly advise you consult with a legal authority on these matters, should you be in need to do a 1031.

What is a 1031 Exchange?

Given its name from the Internal Revenue Code section 1031, a “1031” is the legal swap of like-kind property, which allows the seller who has capital gains taxes to be deferred either fully, or limited, when done correctly. There are many constraints you must follow, including the value of the asset you sell must be equal, or more than the asset you are buying, the timeline and where you place the money from the sale. I will break this down later on. When done properly, this will allow investors to accelerate their growth and wealth enormous amounts, allowing their profits to compound tax free while they execute on this strategy.

The Big Rules to Follow:

1. Find a Qualified Intermediary

When you plan to do a 1031, you are not legally allowed to ever “touch” the money you received from the sale. For that, you hire a 1031 intermediary who acts as the middleman to hold the money until you are ready to buy the replacement property. They will be the one who the buyer sends the money to when you sell, and they’ll be the one ones sending the money to the seller of the property you are purchasing. Three parties all coming together to save lots of money in taxes, very worth it in my opinion.

2. 45 Days: Identification period

Upon closing on the sale of the property you sell, you must identify 1-3 properties you will be looking to purchase with the funds from sale. These properties must be written and sent to the intermediary. You can identify more than 3, but must fall within a certain dollar amount.

3. 180 Days: Closing on the new asset

Running the same timeline as the 45 day identification period, this 180 closing period begins the same day you close on the sale of your old asset. You must close on the new asset within 6 months after the sale. If there are any extra proceeds from the sale of your property after you buy the new asset, you will be required to pay taxes on the difference. (you buy a property for $900,000, but had $1,000,000 of profits from your sale. You would pay capital gains taxes on the $100,000 difference)

There are many other variations of questions to be asked like if you can 1031 your primary residence, or use it for a vacation home. All of these questions should be directed towards a qualified 1031 intermediary. If you want to discuss more, email me at Jason@3pillarsrei.com