How to Get Started with 1031 Exchange Process
As a real estate investor looking to sell properties you have been holding for years, a 1031 exchange can be a perfect option.
It serves as an investment strategy, enabling you to defer taxes on the sale of properties for as long as you want.
A 1031 investment is a great strategy to use, but the truth is that they are somehow complex, and it can be vital to consider the following rundowns to get started with the process:
1. Determine if 1031 Exchange is Ideal for You
While there are many benefits related to 1031 exchanges, ensuring an exchange is suitable for you is vital.
There are several factors, which you need to consider and discuss, including potential tax liability, lifestyle objective, debt considerations, market timing, and structure of property ownership.
2. Know the Types of Exchange Properties
There are different forms of 1031 exchange properties for investment property owners. The IRS needs 1031 exchange properties to include every type of asset, including commercial, residential, and industrial.
Given that every type of property can be considered for 1031 exchange, you can use the above property categories to compare the characteristics and attributes of 1031 exchange assets. Some of the common types of 1031 exchange include:
- Fee simple properties
- Net lease properties
- TIC (tenant-in-common) properties
- DTS properties
3. Enlist Help of QI
Under the 1031 section, any proceeds you receive from selling a property will remain taxable. For this reason, proceeds from sales should be transferred to a QI (qualified intermediary) instead of the seller.
Basically, qualified intermediaries are companies or people who agree to facilitate 1031 exchange by holding finances involved in transactions until they are transferred to a seller of replacement properties. Qualified intermediaries may also have a formal relationship with the party of exchanging properties.
4. Identify a Replacement Property
Once you complete the settlement of properties and the proceeds are sent to the QI, the identification process will start.
During this time, you need to identify different potential replacement properties. It can be three, four, or more.
You will also need to send a letter with some specific details regarding every property to your qualified intermediary.
Begin the search immediately. It can be a good idea to start identifying potential replacement properties immediately after putting your original asset is under a contract.
5. Understand the Rules and Timelines
The odds of getting a person with the exact properties you are looking for are minimum. Because of this, most exchanges can either be three-party, starker or delayed exchange.
When it comes to delayed exchange, you will require a qualified middleman or intermediary to hold the funds on your behalf after selling the property and use it to purchase a replacement property. This process is regarded as swap, and you must observe two main rules, including:
- 180-day rule
- 45-day rule
1031 exchange transactions might help you prevent a short-term capital gain tax and even continue making more wealth in the real estate industry.
However, there are some complicated purchases you will encounter. So you might want to ensure you work with a qualified intermediary and consult tax experts before you proceed.