If you’re looking to sell your current investments to buy another property, it’s integral that you understand everything there is to know about the 1031 tax-deferred exchange. It is an important process that will allow you to sell a property to buy like-kind property, all the while deferring the clutches of capital gains tax.
A 1031 exchange, or like-kind exchange, is named after a section of the IRS tax code, which is a practice that essentially allows taxpayers to defer taxes when they meet certain conditions. It’s easier said than done, however, as these conditions can be tricky, complicated, and overall confusing.
To ensure that you remain on the right track as you plan your like-kind exchange, here are some things you need to take into careful consideration:
1 – 1031 exchanges go beyond just real estate investment
Your 1031 reaches beyond just your real estate property. It encompasses a variety of other entities, but other properties do not qualify. Here are investments that cannot fall under the 1031 exchange:
- Stocks, bonds, other notes
- Partnership prospects
- Inventory and stock in trade
- Debt and securities
- Trust certificates
2 – Understand the property you’re dealing with
Although somewhat vague, the IRS dictates that 1031 exchanges happen only between like-kind properties. They’re defined as properties of the same character, class, or nature. A real property, for instance, can be improved into a residential rental house.
Then, a real property turned into a rental house can be considered as a like-kind to any vacant land, satisfying IRS rules. Keep in mind that planning is key to success, as with any business venture. By understanding the property you’re dealing with, you can come up with a plan that will allow you to avoid costly mistakes.
3 – Revisit your investment goals
If you’re an investor looking to keep your available capital illiquid, 1031 exchanges are worth considering. You’re likely already planning to buy more buildings, or perhaps hold no desire to transition into other investment vehicles.
Remember: properties under the 1031 exchange are bound to investments that are similar in nature. It’s best to know where your investment is going—you’ll be shelling out hefty sums after all.
4 – Know the deadlines
The like-kind exchange poses deadlines that need to be taken into account. Do not miss your identification and exchange deadline under any circumstances, as failure to do so will result in the sale of down leg property to be fully taxable.
You’ll need to identify within the 45-day identification period, and then acquire replacement property within 180 days. Unfortunately, any late identification and replacements will not be accepted.
The like-kind exchange, or 1031, can be an incredibly draining and confusing process. It’s best to come prepared with proper knowledge and tools, as investments should never be taken lightly. There are legal repercussions and costly damages if the 1031 exchange is dealt with improperly, so keep in mind the tips discussed above.
Unfortunately, it may be impossible to do the 1031 exchange by yourself. You’ll need someone to guide you through the entire process, as well as hold on to your funds as you look for prospective properties to purchase.
You’ll need a professional by your side, and our experts at PJL Investments can assist you. We’ll help you understand the entire process, as well as alternative investments you might be interested in!