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The Rules and Steps to Execute a 1031 Exchange

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A 1031 exchange is a real estate investment tax strategy that allows an investor to sell an investment property in exchange for a new property while deferring any capital gains tax. In order to do a 1031 exchange, there are a few rules to abide.

What Are the 1031 Exchange Rules for 2020?

1. Time Restrictions

The exchange starts on the earliest date associated with either of the following:

• The date ownership is reassigned to the buyer
• The date the deed records

Moreover, it ends on the earliest date associated with either of the following:

• The date your return is due (including extensions)
• 180 days after the exchange begins

2. Title Rule

This 1031 exchange rule requires the taxpayers listed on the new property to be those who were listed on the old property.

3. Intermediary Requirement

A property owner looking to do a 1031 exchange cannot have access to the funds in between the sale of the old property and the purchase of the new property. To fulfill the procedure, a qualified intermediary, who is an independent third party, must be used.

4. Reverse Exchange

As one type of real estate 1031 exchange, a reverse exchange does not allow an investor to own both the properties. A property cannot be the one you are buying and the one you are selling, at the same time.

5. Reinvestment Requirements

You have the option of doing a partial exchange instead of reinvesting 100% of the proceeds into another property.

6. Like-Kind Property

Under the like-kind requirement, the property you purchased and the property you sold must be like-kind. Meaning the two properties must categorize as property held for use in trade, business, or investment. It does not apply to personal use properties such as a second home or vacation home.

How to Do a 1031 Exchange

1. Find a Qualified Intermediary

According to the Internal Revenue Service (IRS), as an investor, you are not allowed to execute a 1031 exchange on your own. It must be accomplished within the presence of an intermediary. After signing the contract with the intermediary, your right to collect any kind of profit from the money or property held by the intermediary will be partial. Note that the intermediary will not hold any title to the property.

Choosing the right qualified intermediary is important. The intermediary will work on your behalf to sell the original property, execute the necessary transactions, purchase the replacement property, and more, in order to qualify for a 1031 exchange.

2. Add a Cooperation Clause in your Sales Contract

After you have found a buyer for your old property, you need to ensure to include an addendum declaring that you propose to use the property as part of a 1031 exchange in the contract. In this case, the buyer will not incur any liability or additional expense.

3. Provide a Copy of the Sales Contract to Your Qualified Intermediary

Once you and the buyer agree to the terms and conditions of the sales contract, you need to submit a copy of the sales contract including the contact number of the lawyer conducting the settlement to the intermediary. This is necessary as it will allow the intermediary to prepare documents like the Notification of Assignment, Exchange and Account Agreement, Assignment of Contract, and the Escrow Account Agreement. These documents will be signed and delivered before the completion of the settlement.

4. Exchange Funds Need to be Transferred to an Exchange Account

You will not have ownership of the funds, according to the IRS. Instead, the intermediary will hold the sale proceeds until the exchange is completed. The funds will be wired to an escrow account until then.

5. Nominate a Replacement/New Property within 45 Days

Once the sale of your old property is close, you have 45 days to find a new property. The qualified intermediary will help you identify properties. When you have chosen the properties, you need to identify each one of them in writing. On the other hand, if you aren’t able to identify the replacement property within 45 days, you are not allowed to identify new properties.

6. Close the Deal on the New Property

Once you have identified the replacement property, you have 180 days to complete a 1031 exchange. Hence, you are advised to get started as early as possible from the closing of your relinquished property.

1031 exchanges can be tricky when it comes to investing in real estate. It is important that you find the right qualified intermediary, be diligent in sticking to deadlines, and make sure that all your legal documents are correctly reported to the IRS.

If you are interested in learning more about how to do a 1031 exchange, Register to View All Properties at 1031 Crowdfunding today.