How to use a 1031 exchange?

Question

Hi my name is Dominick Stogner and I am very new to the real estate game. I hear a lot of talk about a 1031 exchange. So my first question is "what and how do you use a 1031?". And also one day down the road I want to own a gym, So "Can I use a 1031 to buy a gym?"

Dave Foster · Answer

@Dominick Stogner, the 1031 will let you ratchet up your portfolio because it lets you sell investment real estate and purchase new investment real estate without having to pay the tax normally due from the gain. You get to defer that tax payment indefinitely and use it for your own profit.

The end game for you would be to use the 1301 exchange process as you buy and sell properties until you finally 1031 into a building to house your gym. Good plan.

The end game for you would be to use the 1301 exchange process as you buy and sell properties until you finally 1031 into a building to house your gym.  Good plan.

Clayton Mobley · Answer

@Dominick Stogner a 1031 exchange is a hugely powerful tool that allows you to, essentially (of course there's plenty of paperwork) exchange one investment property for another without paying taxes on the sale of your property.

Now that is the MOST basic possible explanation. In reality, this is a process that requires (by law) that you enlist the aid of a Qualified Intermediary (there are a couple great ones here on BP). Not only do they make sure all your i's are dotted etc but they serve as a third-party to receive the proceeds of your sale. It is crucial to understand that if you receive money for the sale of a property, the 1031 is void. You MUST have someone else handling the money in order to pull this off.

Some other important things to know, just right off the bat:

• Your QI needs to be in place before you sell.
• 1031s are ONLY for investment property. You cannot use them to sell your primary residence
• There are ways to 'convert' your primary residence to an investment rental, and THEN do a 1031, but it takes time. If you need to sell your primary residence now, a 1031 isn't going to be applicable. (However, the Sec 121 exclusion will shelter up to $250k (single) or $500k (married) of capital gain from taxation.)
• 1031s are only for long-term investment properties. You can't use the 1031 for flips or other short-term investments. There's no hard and fast rule for how long you need to hold a prop before you 1031, but most people use the one-year-and-one-day rule to minimize IRS scrutiny.
• There are rules and timelines to adhere to, yet another reason a QI is so crucial. For example, you must identify (formally) your potential replacement properties within 45 days of closing the sale of your original prop AND you must close on one of your identified properties within 180 days of your sale.
• In order to avoid taxation completely you must purchase a property that has the same value or GREATER than the value of the property you sell, AND, you must have at least as much equity in the new property as you did in the old. You can take on more debt and/or put in more equity, but you can't (for example):Trade a $500k prop with $300k of debt and $200k of equity for a $500k prop with $400k of debt and only $100k of equity.  Trade a $500k prop with $300k debt and $200k equity for a $400k prop with $200k debt and $200k equity. Well, you can, but you'll pay some taxes.
• Trade a $500k prop with $300k of debt and $200k of equity for a $500k prop with $400k of debt and only $100k of equity.  
• Trade a $500k prop with $300k debt and $200k equity for a $400k prop with $200k debt and $200k equity. Well, you can, but you'll pay some taxes.

• Trade a $500k prop with $300k of debt and $200k of equity for a $500k prop with $400k of debt and only $100k of equity.  
• Trade a $500k prop with $300k debt and $200k equity for a $400k prop with $200k debt and $200k equity. Well, you can, but you'll pay some taxes.

If you are looking to get into a 1031 now, I'd recommend you talk to a pro. Start with @Bill Exeter or @Dave Foster . Both are extremely reputable, knowledgable QIs who are active here on BP.

Good luck!

Dave Foster · Answer

@Jared Hauf, Yes you certainly can.  The requirements for reinvestment are that you purchase at least as much as you sell and that you use all of the proceeds.  The way you allocate the proceeds doesn't matter.  What you're talking about is commonly called a diversification exchange and is a great growth strategy for the 1031 investor.

Dave Foster · Answer

@Dominick Stogner, You can sell real estate in a 1031 and purchase the real estate portion of a gym.  But you can't exchange for the non-real estate assets of a gym.

Dominick Stogner · Answer

@Dave Foster ,Thanks for that info.

Dominick Stogner · Answer

Thank you @Clayton Mobley and @Dave Foster for the info it was very helpful. So im really looking into buying an established gym with a 1031, not just a building, is that possible?

How to use a 1031 exchange?

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