The tax break brought on by 1031 exchanges are a helpful tool for both new and experienced real estate investors looking to expand the size as well as number of properties owned. For many, however, this trade-off can be difficult to navigate as investors are required to abide by quite a few rules and regulations. Here, we answer the most frequently asked questions we receive from real estate investors regarding 1031 exchanges.
What disqualifies a property from being used in 1031 exchange?
One of the main requirements for a property being used in this type of exchange is that it must be for the purpose of holding onto an investment and not for resale. Additionally, personal residences do not qualify for this type of exchange.
How long do you have to hold a 1031 exchange property?
There is no specified minimum holding period but it is generally advisable to maintain the property for a period of at least 12 months. This way, the property will appear on two separate tax filings and thus is easier to represent as a hold. However, if a property acquired through a 1031 exchange is later converted into a primary residence, you must hold on to the property for at least 5 years or else it becomes taxable.
How much do you have to reinvest to qualify for a 1031 exchange?
You must reinvest the amount you sold your previous property for as well as take out debt equal to the amount you took out on your first property. For instance, if you take out a loan of $250,000 to purchase a property and end up selling that property for $750,000, you must reinvest the net proceeds in a property at least equal value to the $750,000 and take out at least $250,000 in debt to invest into the new property.
What happens if you do not use all the money in a 1031 exchange?
Since 1031 exchanges aim to create increased real estate investment, properties of a lesser value than the original do not qualify for this exchange. However, if you do not wish to use all the money at once, a partial 1031 exchange can create boot in which it is subject to capital gains and depreciation recapture taxes.
45-day identification period
When undergoing a 1031 exchange, a taxpayer has up to 45 days from the sale of the initial property to identify the property they will be completing the exchange with. This period of time is most commonly known as the identification period. If you do not meet the 45-day window, you can still qualify if you meet one of the three following rules.
- 95% Rule
This rule states that you may identify more than 3 properties in which the total value accrues to 200% of the value of the original property if 95% of the value identified is acquired.
- Three Property Rule
This rule refers to the limit of properties you can claim stating that a taxpayer may identify up to 3 properties and has the option of acquiring one, two or all three properties.
- The 200% Rule
This rule asserts that a taxpayer may identify as many replacement properties as they wish as long as the total market value of the properties identified do not exceed 200% of the relinquished property’s market value.
180-day exchange period
Once the relinquished property has been sold, a taxpayer has up to 180 days to acquire the replacement property or up to the Federal tax return date in which the exchange was initiated during, whichever occurs first. Failure to do so will result in the termination of the exchange.
1031 exchanges can be hard to navigate for even the most experienced real estate investors. If you want to skip the headache of maneuvering through all these rules and regulations, reach out to us today. Upon first contact, we begin our process of supporting you and your real estate accounting needs every step of the way.
At The Hechtman Group Ltd, we understand that tax laws and regulatory and IRS requirements for real estate are vastly different from other financial services. Rich in industry experience, our CPAs and accountants can guide you through all the necessary steps while also creating best practice opportunities for long-term growth.
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