1031 exchanges are popular with investors for various reasons. These exchanges let you defer capital gains taxes, diversify your portfolio, and increase your purchasing power. Learning more about 1031 exchanges helps you complete the process more smoothly.
Investors might wonder what specific types of real estate qualify for 1031 exchanges. You can exchange land with 1031 exchanges if you meet all applicable guidelines.
What Is a 1031 Exchange?
A 1031 exchange is an agreement where investors trade one investment property for another. These exchanges originate from Section 1031 of the Internal Revenue Code (IRC) set by the Internal Revenue Service (IRS). If transactions meet the IRC standards to qualify as a 1031 exchange, real estate investors can defer capital gains taxes. Investors can swap or upgrade properties without incurring a large tax bill, which allows them to use more of the profit from the sale on a new investment property.
You can engage in a 1031 exchange for various reasons, including:
- Reducing property depreciation: An investor can exchange a depreciated property for a new one while avoiding depreciation recapture in a 1031 exchange. Depreciation recapture is when an investor pays taxes on the profit from selling a depreciated property, which is normally taxed as ordinary income.
- Consolidating properties: Many investors use 1031 land exchanges to consolidate multiple properties into one. Consolidation eliminates duplicate assets, which can help lower expenses over time.
- Increasing return on investment (ROI): 1031 exchanges can increase your cash flows. For instance, you could exchange vacant land for a commercial property that has the potential to generate more revenue.
- Diversifying your portfolio: The exchanges help diversify your portfolio to include new property types and different locations.
Can You Buy Land With a 1031 Exchange?
Vacant land qualifies for 1031 exchanges as long as it meets all IRS requirements, including:
- The land must be like-kind: Your replacement property must be similar to your existing property. According to the IRS, like-kind properties should have the same character and both be located in the United States.
- The land must be for business purposes: Investors can only use 1031 exchanges for business or trade, making personal properties largely ineligible.
- The new property must be an equal or greater value: The purchased property’s net market value and equity must be equal or greater than the sold property to qualify for capital gains deferment.
In addition to these standards, the 1031 exchange for land must occur within a specific timeline. You must identify one or more replacement properties for your exchanged land within 45 days, and the entire exchange must be finished in 180 days. If you do not meet these deadlines, the sale no longer qualifies as a 1031 exchange.
How to Use a 1031 Exchange to Buy Raw Land
Follow the standard steps in a 1031 exchange process to complete your land purchase. With the right research and preparation, the process can proceed smoothly.
These are five basic steps of a 1031 land exchange:
1. Select a Qualified Intermediary (QI)
Qualified intermediaries are financial professionals that oversee the 1031 exchange process. They work as a mediator between the two parties. The QI could be an individual, entity, company, or other qualified party.
QIs create documentation of the exchange, ensuring all necessary documents and communication are involved. Later, they submit the documentation to prove the exchange occurred in the required timeframe and the land met all requirements. QIs also manage the transfer of funds — they hold onto the proceeds from your sale and transfer it to the replacement property owner at the correct time.
The QI provides in-depth advice throughout the 1031 exchange. They can answer questions, make recommendations, or remind you of upcoming deadlines.
Your QI has an integral role in the land exchange process, so choosing the right professional is important. It helps to look for these traits:
- Experience levels: QIs with more experience can often provide more effective assistance. A history of successful 1031 exchanges for raw land indicates they can assist with this specific exchange type.
- Customer service: QIs with strong customer service answer questions and provide ongoing support rather than just overseeing the exchange. You can use online reviews and testimonials to determine a QI’s level of client support.
- Manageable expenses: You should also identify QIs with prices that fit into your budget. Some might offer a flat rate, while others have scaled pricing depending on the services. Researching this ahead of time helps you stay within budget.
2. Prepare Exchange Documents
After you select a qualified intermediary and the property you want to sell, you can prepare the necessary documents to begin the exchange. The QI can help you draft a contract that outlines the purchase or sale agreement. QIs can also develop the documents that convert the sale agreement into an official exchange.
3. Sell Your Current Property
Once the documents are prepared, you can sell your current property. Remember that as soon as the sale finishes, you have 45 days to identify the replacement property or properties.
4. Choose the Raw Land Property
Next, you identify the land you want to select as your replacement property. Some investors already have the replacement land in mind when they begin the process, while others start looking later. You should research options thoroughly and ensure they meet the qualification rules for 1031 exchanges, such as the like-kind rule. Your QI can help you narrow down available properties. You must choose a replacement property by midnight on the 45th day after closing, or the trade no longer qualifies as a 1031 exchange.
5. Finalize the Exchange
After identifying the replacement land, you enter a contract agreement with the new party. Your QI drafts the documentation for the new purchase and exchange procedures. Then, the QI transfers the funds from your sale to the replacement land owner and the official ownership rights to you.
Complete a 1031 Exchange With 1031 Crowdfunding Today
You can diversify your portfolio and acquire new land with 1031 exchanges. The right preparation helps the process proceed more easily.
Real estate investment platforms help you get started with 1031 exchanges and other real estate transactions. Choose 1031 Crowdfunding today for a high-quality investment platform. While we don’t offer qualified intermediary services, our platform of replacement properties can supplement or benefit your financial plans. Our team has extensive experience with real estate transactions, helping you reach financial goals. Our platform lists a wide selection of replacement 1031 properties, letting you find a match that aligns with your preferences and specifications. We guide you through the process and help finalize the exchange.
To get started with 1031 Crowdfunding, register for an investor account today.
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