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1031 Exchange: What Real Estate Investors Need To Know

As a real estate investor, taxes are just part of the deal. However, 1031 exchanges, which are named for the IRS Section 1031 of the IRS’s tax code, allow you to sidestep capital gains.

We’ve put together some tips about 1031 exchanges as well as some of the most important related rules you must follow.

What Is A 1031 Exchange?
A 1031 exchange is a real estate investing tool that allows investors to swap out an investment property for another and defer capital gains or losses or capital gains tax that you otherwise would have to pay at the time of sale. This method is popular with investors looking to upgrade properties without being charged taxes for the proceeds.

You’ll also hear 1031 exchanges referred to as a like-kind exchange or a Starker exchange. Section 1031 applies to property beyond real estate, but many 1031 cases also deal with buildings and land.
How Does A 1031 Exchange Work?
As a seller, you can postpone capital gains taxes by selling a property and putting the proceeds toward a like-kind property, or property similar in nature and value.

If you don’t receive any proceeds from the sale, there’s no income to tax. In other words, you gain no profit from the sale. That’s the idea behind a 1031 exchange, and here’s how to make that work:

Step 1: Identify The Property You Want To Buy And Sell.
The property you’re selling and the property you’re buying must be "like-kind," which means they must be similar but not necessarily the same quality or grade.

Step 2: Choose A Qualified Intermediary.
You must work with a qualified intermediary, also known as an exchange facilitator, on a 1031 exchange. The qualified intermediary holds your funds in escrow for you until the exchange is complete. Choose the right qualified intermediary so you don’t lose money, miss key deadlines or end up paying taxes now instead of later.

Step 3: Tell The IRS About Your Transaction.
Lastly, you’ll need to tell the IRS about your transaction through IRS Form 8824 with your tax return. On that form, you’ll describe the properties, provide a timeline, explain who was involved in the process and list the money involved.

Both the relinquished property you sell and the replacement property you buy must meet certain requirements.

Relinquished Property
The relinquished property is being exchanged for another in a 1031 exchange. It’s also known as Phase 1 or Downleg.
Replacement Property
A replacement property refers to the like-kind parcel being bought with the proceeds from the relinquished property.

What Is A Qualified Intermediary?
A qualified intermediary is a person or company that sells your property on your behalf, buys the replacement asset, then transfers the deed to you. The qualified intermediary is responsible for holding the proceeds from the 1031 exchange real estate transaction so that the sale is not taxable, handling the transition of funds from the investor exchanging like-kind properties and the seller of the replacement property, preparing the legal documents and ensuring that the transaction is completed within IRS guidelines.

Let’s dig into a qualified intermediary’s job responsibilities a little further. They will:

*Coordinate with you, the seller, on the structure of the 1031 exchange.

*Prepare the relinquished asset documentation and the replacement property documentation.

*Give instructions and the appropriate documents to the escrow or title company about the exchange.

*Create an arm’s length transaction in the agreement between the seller or exchanger and the qualified intermediary.

*Transfers to the qualified intermediary, who works to convey the asset to the buyer.

*Handles money from the relinquished property sale and deposits these funds into a separate and insured account.
*Holds the funds from the sale of the relinquished property during a 45-day identification period.

*Holds written information about potential replacement properties.

*Transfers funds once the replacement property has been selected and disburses them to the title or escrow company for the purchase of the replacement property.

*Conveys the title to the seller or exchanger by deed.

*Keeps complete records for the seller.

*Gives a 1099 to the seller or exchanger and the IRS if needed, for interest.

It’s important to choose the right qualified intermediary for you. Confirm that the qualified intermediary you’re considering offers:

*Real estate experience. Does the qualified intermediary have extensive real estate experience?

*Successfully completed compliance examinations. Processes should meet annual compliance examinations, such as SSAE 16.

*Transparency in transactions. Can you view your exchange money at all times? You want to know what’s happening with your money at all times.

*Fund security. Make sure your funds are held in an FDIC-insured account for safety.

When To Use A 1031 Exchange
There are multiple reasons why you might want to use a 1031 exchange. You may want to:

*Invest in a property with better return prospects than your current investment property.

*Consolidate several properties into one, possibly for life estate planning purposes.

*Reset the property’s depreciation.

*Turn your vacation home into a rental property and do a 1031 exchange. (Here’s an example of how that can work: You stop using your beach house, rent it out for a few months, then exchange it for another property.)

*Sell your investment property and invest in more than one property. For example, you can buy three investing properties if you want to – there’s no limit. However, if you buy more than three, your qualified intermediary will have to go over some extra rules with you.

1031 Exchange Rules And Requirements
Here, we list the rules and regulations that pertain to a 1031 exchange, including property requirements and time requirements.

Property Requirements
The property you exchange must abide by certain requirements:

*The replacement property must be like-kind, or of equal or greater value to the relinquished property. Both properties must be similar enough to qualify as "like-kind." Most real estate can be like-kind to other real estate. For example, real property improved with a residential rental house is considered like-kind to empty land. Note that property within the United States is not like-kind to property outside of the United States.

*The exchanged properties must be similar in nature and function. For example, a rental or multifamily property cannot be exchanged to acquire a vacation home. Personal use residences, such as a primary residence, second home or vacation home, do not qualify as like-kind exchanges. Actual property and personal property (which can include machinery, equipment, collectibles, vehicles, boats, aircraft, artwork, patents and other intellectual property) can both qualify as exchange properties under Section 1031 but actual property can never be like-kind to personal property. The rules are more restrictive for personal property as well. For example, cars are not like-kind to trucks.

*You cannot hold the money made from a sale during the exchange at any time. All funds must be held in escrow by a qualified intermediary or the proceeds will become taxable.

Finally, Section 1031 does not apply to these types of exchanges:

    *Stocks, bonds, or notes
    *Other securities or debt
    *Partnership interests
    *Trust certificates

Time Requirements
You must also adhere to specific timelines with a 1031 tax exchange or the gain on the sale of your property may become taxable:

*You have 45 days after the sale of your relinquished property to find potential replacement properties. You must do so in writing and share it with the seller or your qualified intermediary.

*You must close on the replacement property within 180 days of closing on the relinquished property or after your tax return is due – whichever is earlier.

Types Of 1031 Exchanges
You may want to look into three types of tax-deferred exchanges – delayed exchanges, reverse exchanges and build-to-suit exchanges. Consider the following:

Delayed Exchange
A delayed exchange is the most common exchange format because it offers you flexibility of up to a maximum of 180 days to purchase a replacement property. If the relinquished property is sold before you acquire the replacement property, the sale proceeds go to your qualified intermediary. The qualified intermediary holds the money until you acquire the replacement property and your qualified intermediary will deliver funds to the closing agent.

Reverse Exchange
A reverse exchange, or forward exchange, involves closing on the purchase of the replacement property before you close on the sale of the relinquished property. You may want to tap into this option to get a desirable replacement property when it’s a seller’s market, especially if you encounter competing offers or a pressing need to close quickly.

When a replacement property is purchased before the sale of the relinquished property, again, the property must be transferred through an exchange accommodation titleholder – the qualified intermediary.

Built-To-Suit Exchange
A built-to-suit exchange, also known as a construction exchange or improvement exchange, is an exchange that allows the deferred tax dollars to be used towards renovations of the replacement property. The improvements must be completed within the 180-day period.

Tax Implications Of A 1031 Exchange
You may encounter some tax implications as a result of doing a 1031 exchange. Consider the following:

*Capital gains may occur for leftover cash, known as the “boot,” following an exchange.

*If the mortgage on the replacement property is lower than the one of the relinquished property, you may get taxed on the difference.

*You’ll get taxed for the sale of the relinquished property if the sale is unsuccessful.

*If you enact many 1031 exchanges over the years, these can yield deferred gains numbering in the hundreds or thousands, increasing your tax liability.

The Bottom Line
Normally, you can roll over your investments into new properties indefinitely, but as soon as your investment is rolled over into a different asset (such as sold for cash) you’re on the hook for the capital gains tax once the final asset is sold.

It’s possible to avoid this process and defer your capital gains taxes. You may be able to use a 1031 exchange as long as the proceeds from the sale and the principal investment are reinvested into a new property within 180 days.

1031 exchanges pose some restrictions on the type of property that qualifies for a 1031 exchange. 1031 Exchanges require that the replacement investment be of “like-kind” to the investment being sold. As long as the property is being used for commercial or investment purposes, it qualifies as “like-kind.”

You’ll need a qualified intermediary to facilitate the 1031 exchange on your behalf. A qualified intermediary is a person or company who sells your property on your behalf, buys the replacement asset, holds the proceeds from the real estate transaction so that the sale is not taxable, handles the transition of funds, prepares the legal documents and ensures that the transaction is completed with IRS guidelines in mind.
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Patricia A
. Flowers, Vice President | Certified Exchange Specialist®
Investmen
t Property Exchange Services, Inc. (IPX1031)
265 Franklin Str
eet, 8th Fl • Boston, MA 02110
o: 617.423.1031  tf: 877.781.1031  m: 617.899.4718
tff: 888.310.1868    
e: patricia.flowers@ipx1031.com  w: www.ipx1031.com/flowers



What my clients are saying  

Maureen was fantastic from start to finish. She made sure I understood all that was happening and what to expect. She is very easy to work with, knows how to treat her clients and made sure things were clear and understood throughout the entire process. I will highly recommend her to anyone looking to purchase a home.

 

~ Frank Tarallo, Methuen

Maureen was a very calming person during selling of my home. She was very knowledgeable in all the steps to make it a successful home sale. Was always available if I had any questions and explained the whole process. You can tell Maureen enjoys helping people thru this journey of selling their homes and is dedicated to the seller and buyer making sure it all goes well.

 

~ Rosemary Farrell, Malden

Maureen is a true professional. She came to the initial meeting with all the relevant information and answered all our questions. During the process, she was in constant communication, and she was able to listen and gave her advice when there were numerous requests for financing extensions. She was able to get the answers I needed in order to grant to those extensions. I am so pleased we were referred to Maureen. Couldn’t have asked for a better realtor.

 

~ Reggy Roycroft, Medford

Maureen is great! I definitely would recommend her to everyone.

 

~ Lidia Lekhter, Stoneham

Maureen was easy to reach, very knowledgeable, and kept me calm during the process of buying my first home. She understood what my priorities were and helped me find a spot that suits me perfectly.

 

~ Marissa McQueeney, Malden

Even though my house was sold “as is”, she gave me educated advice about basic repairs. She also went over and above the process because I broke my ankle in the middle of the confusion. She guided me to very reliable contractors who promptly responded to all my needs. I can’t say enough about her attention and professionalism I was dealing with the recent death of my mother and overwhelmed with all the legal issues. Maureen took the ball and ran. Between this emotional issue and breaking my ankle in the middle of the move, I NEVER would have gotten through it without her help and understanding!

 

~ Joanne Muse, Melrose

Maureen was a pleasure to deal with. If we had questions, she had answers. No matter what time of day or what day it was she always responded. You never had to ask her twice. The sale of our home was very smooth and with no problems. Everything was handled in a timely manner. Maureen is a very knowledgeable. She treats you with respect and is always there for you.

 

~ Nancy Gochis, Everett

In today's market having to sell and buy a home can be very stressful. By choosing Maureen both transactions went smoothly. Any questions or worries we had, were taken care of promptly and without concern. We could not have asked for a better real estate broker.

 

~ Michael G., Peabody

Maureen was incredible and made the process of buying a home for the first time easy and fun. She was great about setting up showings and planning an itinerary for me, since I was coming from out of state to view places. Throughout the search process, she was super responsive to all of our requests and questions. When we had an offer accepted, she clearly laid out next steps, and made everything simple right through closing. Her recommendations for inspectors and lawyers proved to be stellar, and we had a great experience with everyone she referred. Maureen's years of experience were evident throughout the entire experience, and we would recommend her without reservation to anyone!

 

~ John Hervey, Boston

Maureen is a very friendly, professional person. She was always accessible via phone or text. We appreciated her insights and tips as first-time homebuyers. Plus, she was always super kind to our puppy. We could not have done this without her and her knowledge!

 

~ Adriana Leon, Lowell

Even through the terrible market of the pandemic, Maureen stuck with us. We had the longest ongoing search of a home with 13 offers over a year. She must have seen over 50 houses with us. She went above and beyond.

 

~ Kathryn & Mike Muse, Lynn

I received a flyer in the mail and decided to contact Maureen. I selected her because she responded immediately and explained the process and walked me through it every step of the way. She was beyond amazing and always available. She handled my every concern and request, and I never had to revisit issues or remind her of anything. She is such a go-getter, and her experience is all you need when selling your house! I hit the jackpot when I selected Maureen. I have worked with many realtors in the past 25 years of selling and buying homes, and no one compares to Maureen. I am so happy to have met her when I listed my home, and I now consider her a friend. She eased my mind throughout the whole process and her experience and dedication is beyond perfection! She kept the whole process so organized and guided me flawlessly. She made something that is normally very stressful - a very peaceful easy experience. Thank you for making my home sale transaction seamless! You rock!!!

 

~ Stacey Joyce, Medford

Maureen was great and understood all my needs throughout my home search. She always kept me informed about everything and made the process easy to deal with from start to finish.

 

~ Fred Wilson, Medford

Maureen was patient and knowledgeable.... she helped in any way she could... very accommodating, punctual and organized. She always put my mind at ease. Maureen was a pleasure to work with. I strongly recommended her to prospective sellers and buyers.

 

~ Lydia Kalustian, Medford

Maureen was very professional and knowledgeable. She was extremely helpful throughout the entire process. She also had professional contacts for services that were greatly helpful. My experience with Maureen was wonderful and I would gladly use her services again.

 

~ Dennis Shepard, Everett

I've enjoyed working with Maureen for the past 8 years selling and buying properties around the Boston area. Maureen is an excellent agent with lots of experience and knowledge; Thank you Maureen for a great job selling my condo and it's much appreciated for making it a smooth transition.

 

~ Michael Zalt, Lynn

We could not have asked for a better agent than Maureen. My son highly recommended her and we will definitely recommend her to anyone looking to sell or buy a new home.

 

~ Donna and Roger Richmond, Peabody

Maureen is an amazing real estate agent. She is knowledgeable, friendly and ever patient. I’ve bought a home with her, then sold it and bought a new one. Throughout Maureen provided logical, solid advice based solely on my needs. Thanks Maureen!

 

~ Jasna Nightingale, Malden

Maureen is an excellent broker. In addition to be knowledgeable, punctual and professional, she is also very kind. She went above and beyond to help my husband and I with our questions and concerns. She keep us informed, had sound advice, and was always available and responsive. I highly recommend Maureen!!

 

~ Fabiana Stark, Medford

Maureen handled our sale with great proficiency, knowledge, and tact. We would recommend her VERY highly with no reservations!

 

~ The Miller's, Revere

Professional, dependable, honest, respectful and friendly.

 

~ Aleta Dean, Malden

We were very happy with the service Maureen provided. She already kept us informed, have sound advice, and was always available and responsive.

 

~ Jim Zvara, Lexington

I would recommend Maureen because she is a person that gets the job done.

 

~ Ann Green, Malden

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