1031 Property Exchange Resources & Basics
In simple terms, a 1031 like kind exchange rolls the gains from the sale of an old property to a new property. Exchanging is one of the last great real estate tax savings strategies available to real estate investors. IRC Section 1031 allows an investor to sell a property, reinvest the proceeds into a new property, and defer all capital gains taxes. Here is an example to help illustrate the power of the 1031 like kind exchange:
An investor has a $200,000 capital gain when selling a property and incurs a tax liability of approximately $70,000 (depreciation, federal and state capital gain taxes) upon closing. The investor would be left with only $130,000 to reinvest in another property. If they plan to finance a new property purchase with a 25% down payment (75% LTV ratio), they would only be able to acquire a $520,000 asset. However, if the same investor chose to do a 1031 like kind exchange, they would be able to reinvest the entire $200,000 of equity received from the initial sale, which would allow them to purchase an $800,000 asset assuming the same down payment and LTV ratio noted above. In this example, the exchange process effectively increased the investor’s buying power by approximately 50%, while also deferring taxes from the initial sale.
1031 Like Kind Exchange Terms:
- Actual Receipt – physical possession of proceeds.
- Boot – “non like-kind” property received. “Boot” is taxable to the extent there is a capital gain.
- Cash Boot – any proceeds actually or constructively received by the Exchanger.
- Constructive Receipt – even if an investor does not have actual possession of the proceeds, they are legally entitled to the proceeds in some manner such as having the funds held by an entity considered as their agent or by someone having a fiduciary relationship with them, thus creating a taxable event.
- Direct Deeding – transfer of title directly from the Exchanger to Buyer and from the Seller to Exchanger after all necessary exchange documents have been executed.
- Exchanger – entity or taxpayer performing an exchange.
- Exchange Period – the period of time in which replacement property must be received by the Exchanger. Ends on the earlier of 180 calendar days after the relinquished property closing or the due date of the Exchanger’s tax return.
- Identification Period – a maximum of 45 calendar days from the relinquished property closing to properly identify potential replacement property(s).
- Like-Kind Property – any property used for productive use in trade or business or held for investment. Both the relinquished property and replacement property must be considered “Like-Kind” to qualify for tax deferral.
- Qualified Intermediary – the entity who facilitates the exchange. Defined as: (1) not a related party, (2) receives a fee, (3) receives the relinquished property from the Exchanger and sells to the buyer, (4) purchases the replacement property from the seller and transfers it to the Exchanger.
- “Down-leg” – process in which the relinquished property is sold and all respective paperwork for that process is completed.
- “Up-leg” – process in which the replacement property is acquired and all the respective paperwork for that process is completed.
- Reverse Exchange – replacement property is acquired prior to closing the sale of the relinquished property. Accomplished by creating an exchange accommodator titleholder (“EAT”), who technically owns the parked property so that the Exchanger remains in accordance with the 1031 exchange guidelines without having title to both the relinquished and replacement properties at the same time.
Read about 1031 exchange rules and the exchange process, plus the 1031 exchange replacement property FAQ to learn more. If you are interested in making a 1031 like kind exchange and would like assistance in locating investment property, or you have questions, contact HighStreet Net Lease Group.