1031 in a nutshell

Fort Wayne, IN · Member since 2016 · 38 posts · 7 votes

Hey BP, Could someone give me a run down of how 1031 exchanges work? I understand that the benefit is you do not have to pay capital gains tax, but how does it work exactly? Any feedback would be great. Thanks, Tom

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

10y

Big topic for a little nutshell. Best thing is to determine where you want to go and then make 1031 fit into it for you rather than adjust your business model and goals to accommodate 1031. But bottom line is that by following a few guidelines you can sell investment real estate that would ordinarily trigger a tax and instead buy new investment real estate and by following those guidelines you do not have to pay the tax. It is deferred into the new property where it stays until you sell or you can sell doing a 1031 exchange and defer again, or you can die and will it to your heirs who get it with no gain, or you can convert it into your primary residence and eliminate a portion of the gain or or or....

Summary of the guidelines

1. The order is sell then buy. And any kind of investment real estate may be purchased to replace any other kind of investment real estate

2. You must use a qualified intermediary and they must be in place prior to the sale of the old property. You may not touch the proceeds in between sale and purchase.

3. You have 45 days after sale to identify your potential replacements. The entire process must be done within 180 days of close of sale.

4. The tax payer for the old property must be the same as the tax payer for the new property.

5. In order to defer all tax you must purchase at least as much (dollar amount not number of properties) as you sell (net sale after closing costs but before mortgage pay off) and you must use all of the proceeds in the next purchase or purchases.

Lot's of google resources. Lots of us have good primers on our web sites. BP has a primer somewhere also on this site. Maybe someone can point you to it.

Holler any time.

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y
Big topic for a little nutshell. Best thing is to determine where you want to go and then make 1031 fit into it for you rather than adjust your business model and goals to accommodate 1031. But bottom line is that by following a few guidelines you can sell investment real estate that would ordinarily trigger a tax and instead buy new investment real estate and by following those guidelines you do not have to pay the tax. It is deferred into the new property where it stays until you sell or you can sell doing a 1031 exchange and defer again, or you can die and will it to your heirs who get it with no gain, or you can convert it into your primary residence and eliminate a portion of the gain or or or....
Summary of the guidelines
1. The order is sell then buy. And any kind of investment real estate may be purchased to replace any other kind of investment real estate
2. You must use a qualified intermediary and they must be in place prior to the sale of the old property. You may not touch the proceeds in between sale and purchase.
3. You have 45 days after sale to identify your potential replacements. The entire process must be done within 180 days of close of sale.
4. The tax payer for the old property must be the same as the tax payer for the new property.
5. In order to defer all tax you must purchase at least as much (dollar amount not number of properties) as you sell (net sale after closing costs but before mortgage pay off) and you must use all of the proceeds in the next purchase or purchases.
Lot's of google resources. Lots of us have good primers on our web sites. BP has a primer somewhere also on this site. Maybe someone can point you to it.
Holler any time.
The 1031 Investor5137 Reviews
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Issac Cardona
Flipper/Rehabber · San Diego, CA · Member since 2015 · 23 posts · 4 votes
10y
@Davefoster Good info !
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
10y
Originally posted by @Tom Tippmann:

Hey BP,
Could someone give me a run down of how 1031 exchanges work? I understand that the benefit is you do not have to pay capital gains tax, but how does it work exactly? Any feedback would be great.
Thanks,
Tom
Hi Tom,
I'll try to simplify it for you. The whole idea behind a 1031 Exchange is that you can defer the payment of your capital gain and deprecation recapture taxes if you remain fully invested. You keep 100% of your money in your pocket working for you instead of the government. Here are the basic requirements:
- Qualified Intermediary: You must have selected your Qualified Intermediary and have your 1031 Exchange set-up and in place prior to any closings. The transaction will not qualify for tax-deferred exchange treatment if any of your transactions close before the 1031 Exchange has been set-up.
- Qualified Use Requirement: The properties that you sell and then the properties that you ultimately reinvest in (buy) must be held for rental, investment or business use. It is your intent to hold for rental, investment or business use that is critical.
- Like-Kind Property Requirement: Like-kind simply means that you are selling real estate and must therefore buy real estate. It does not mean condo for condo. Any kind of real estate will qualify as long as it meets the Qualified Use test.
- Reinvestment Requirement: The property that you reinvest in must have a value that is equal to or greater than the net sale price of what you sold. In other words, you must trade equal or up in value.
- 1031 Exchange Deadlines: You have 45 calendar days from the closing of your sale transaction in which to identify your potential replacement properties, and you have an additional 135 calendar days in which to complete your purchases, for a total of 180 calendar days.
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Joel Sherlock
Kelowna, British Columbia · Member since 2016 · 61 posts · 108 votes
10y
Great post gentlemen! Thank you @Bill Exeter and @Dave Foster for sharing your breakdowns.
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Kevin L.
Residential Real Estate Agent · Ashburn, VA · Member since 2015 · 35 posts · 4 votes
10y
Hi, just want to clarify that the entire proceeding from the sale will be held, not just the "gain", correct?
A simple example, if I bought a rehab for 300K, spent $45K fixing it up and sold for 400K. The entire 400K will be held by QI, not $100K, and not $55K either.
Is that correct?
Thank you for answering!
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David Fernandez
Real Estate Agent · Vienna, VA · Member since 2016 · 289 posts · 253 votes
10y
@Dave Foster and @Bill Exeter Wow, thank you very much for your info. You summarized in one post what I was looking for!
However, I have an additional question. It seems from one of your posts that the tax payer form the old property must be the same tax payer in the new property. My wife and I bought an investment property a few years ago under both our names and we would like to do a 1031 exchange with a different property we already like. However, we would like to purchase this new property with our LLC.
Can we do a 1031 with our LLC or we have to be on the title?
Thank!
David
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Leslie Pappas
Professional · San Francisco, CA · Member since 2014 · 876 posts · 301 votes
10y
I agree with all the advice you've been given in this thread. Regarding 1031 Exchange and syndications, if you are an accredited investor, you can buy into institutional grade $50-125M projects with as little as $100,000 and diversify for some added safety. Professionals with decades of experience and very impressive track records do all the heavy lifting for you. You get potential cash flow, tax shelter and appreciation. Loans are non-recourse. This is the world of Delaware Statutory Trusts. I wrote a book on this which was released in January called Cashing In Tax Free.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y
@David Fernandez, You may be able to do that. It depends on the nature of that LLC. If the LLC does not file it's own tax return and all activities of the property will be reported on your personal Schedule E then that LLC is disregarded as a tax payer and the service will look to you and your wife as the taxpayer. So you can sell as yourselves, use a 1031 and buy as the LLC.
If the LLC is not disregarded and files it's own return then you must sell as yourselves, buy as yourselves. But after the fact you can work with your accountant to then contribute that property to your LLC making sure to not trigger a taxable event.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
10y
Originally posted by @David Fernandez:

@Dave Foster and @Bill Exeter Wow, thank you very much for your info. You summarized in one post what I was looking for!
However, I have an additional question. It seems from one of your posts that the tax payer form the old property must be the same tax payer in the new property. My wife and I bought an investment property a few years ago under both our names and we would like to do a 1031 exchange with a different property we already like. However, we would like to purchase this new property with our LLC.
Can we do a 1031 with our LLC or we have to be on the title?
Thank!
David
Hi David,
You live in Florida, which is not a community property state. Generally, an LLC with two or more members is treated as a partnership for tax purposes. A partnership would not be treated as the same as you and your wife - it is a completely different entity for tax purposes.
It would be different if you were in a community property state. A husband and wife in a community property state are considered a single member for LLC purposes and therefore the LLC would be considered a disregarded entity and not a partnership. You could then sell as husband and wife and buy as the LLC (disregarded entity).
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y
@David Fernandez, Community property states or equitable distribution states are descriptive of state statutes and determinations on property ownership and distribution in divorce and can influence but not dictate federal tax treatment - especially in an equitable distribution state like Florida. Variations are common. The easiest way to determine is to ask your acct. If your LLC has to file it's own return it would be the tax payer for the property. You'll need to complete your 1031 as husband and wife and then work with your acct. to get it into the LLC. If activity of the LLC is reported on your jointly filed sched E then it is disregarded for federal purposes of sec 1031 irrespective of the state you reside in. You may sell as husband and wife and buy as the LLC.
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David Fernandez
Real Estate Agent · Vienna, VA · Member since 2016 · 289 posts · 253 votes
10y
@Bill Exeter, @Dave Foster thank you again for sharing your knowledge.
As I understand from your replies, I should first contact my accountant to check how our LLC taxes are being reported, but regardless of this, I will be able to do a 1031 with this property by either buying and selling as husband and wife or selling as husband and wife and buying as LLC.
In case we have to buy and sell as husband and wife, I will ask my accountant about how to contribute the new property to our LLC; however, would this not disqualify the 1031? Would this still be viewed as holding the property for investment purposes?
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Eugene Kemp
Ormond Beach , FL · Member since 2015 · 345 posts · 223 votes
10y
Google 1031 Exchanges for Dummies. Then find a QI.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y
@David Fernandez, contributing property after the fact is not a demonstration of change of intent. What you would be doing is changing the holding entity for liability or investment purposes. Your intent is still to hold the property for productive use - just in a different manner. The key will be making sure your acct contributes the property in a manner that would not be deemed a sale and does not trigger a tax event. You are correct though you're good to go with your 1031 either way. Hi @Eugene Kemp both myself and the other poster answering questions on this string are QI's. Holler if I can be of service.
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Ahmed Mahmoud
Investor · Round Rock, TX · Member since 2015 · 4 posts · 0 votes
10y
Great post!! Thank you all for the info. Question whether the following scenario is valid for 1031 exchange. You sell an investment property (rental SFH) and you use the funds to hire a builder to develop a multifamily rental on a lot you already own. Would 1031 help in this case to avoid paying the taxes on the gains from the sale of the rental SFH?
Thank you all very much.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
10y
Originally posted by @Kevin L.:

Hi, just want to clarify that the entire proceeding from the sale will be held, not just the "gain", correct?
A simple example, if I bought a rehab for 300K, spent $45K fixing it up and sold for 400K. The entire 400K will be held by QI, not $100K, and not $55K either.
Is that correct?
Thank you for answering!
Hi Kevin,
Yes, this is correct. The amount that you must reinvest is the net sale price. It would be $400,000 less your routine selling expenses (broker's commission, title insurance costs, escrow fees, closing attorney fees, recording fees, etc.) in this case.
You mentioned rehab. It is important to note that to qualify for a 1031 Exchange you must have the intent to hold for rental or investment purposes. Acquiring a property as a rehab/flip property is actually considered holding for sale and not holding for investment purposes and would not qualify for 1031 Exchange treatment.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
10y
Originally posted by @Ahmed Mahmoud:

Great post!! Thank you all for the info. Question whether the following scenario is valid for 1031 exchange. You sell an investment property (rental SFH) and you use the funds to hire a builder to develop a multifamily rental on a lot you already own. Would 1031 help in this case to avoid paying the taxes on the gains from the sale of the rental SFH?
Thank you all very much.
Hi Ahmed,
It is possible, but not without risk.
The general idea of a 1031 Exchange is that you must reinvest by acquiring an interest in real estate that you do not already own. In this case, since you already own the land that you want to build on so you would have to structure what we call an Advanced Improvement 1031 Exchange.
There are only three (3) Private Letter Rulings ("PLRs") from the IRS/Treasury on these structures and the PLRs can not be relied up or cited as precedent, so they provide guidance but no assurance that your transaction would not be disqualified.
Essentially, the dirt is leased to the Exchange Accommodation Titleholder ("EAT") under a 30 plus year ground lease. The ground lease and the improvements would be the replacement property that you identify and acquire as part of your Advanced Improvement 1031 Exchange.
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