Breaking Down the 1031 Exchange

A 1031 exchange (also called a Stalker exchange or like-kind exchange) is a way to defer the capital gains taxes and the depression recapture of an investment property to another like-kind investment. Like-kind refers to the type of investment meaning you can not exchange real estate for a business. While the government is giving you a loan on the taxes owed, there are a lot of stipulations with these exchanges. There are some strict timelines and doing a 1031 exchange is not always the best strategy for every situation.

Beginning with the first property, you must hold it for at least a year and purchase another rental property (residential or commercial) with those funds. This could be a previous primary residence or vacation home but the restrictions on those are a lot stricter. Before you decide to sell, you will want to get in touch with a 1031 qualified intermediary (QI) and make sure all your ducks are lined up. They will be facilitating the transition (not transaction) and keeping you in line with all the mandated requirements.

Once you are under contract to sell your property, you should start looking at replacement properties. After your first property closes, you have 45 days to identify three properties that you would like to purchase. From that point, you have 135 days (180 days total) to close on one of those three properties.

There are a few things to consider when deciding if this is the right decision for you. The replacement property must be more expensive than the original property. Also know that one of the biggest downsides to a 1031 is the time restrictions. Because of that, you probably will not be able to find a great deal. Hopefully, the money you are saving by deferring your taxes will help ease the burden. One last thing to note is you will never be in possession of the funds from the sale. The QI will hold these funds for you. If you do want to keep part of the proceeds, those can be released to you and you will be responsible for paying tax on that portion.

A 1031 can be a powerful tool to help grow your portfolio when used correctly. Just make sure you have contacted a 1031 specialist long before you are ready to sell your initial property.