Simply put, a 1031 exchange is a tax break given by the IRS on the sale of an investment property. Typically, when you sell a property, you need to pay taxes on any gains (“capital gains tax”) you make from the sale. With a 1031 exchange, however, you can delay paying taxes on that gain if you reinvest the net sale price of the property into a similar, or “like-kind”, investment property of equal or greater value.
As with any other tax situation, however, there are important details to consider before entering into a 1031 exchange.
First, what exactly does “like-kind” mean? In the eyes of the IRS, “like-kind” is a very broad term. As long as both the property you are selling and the property you are buying are used solely for investment purposes (and they are real estate), they generally qualify for a 1031 exchange. Eligible property types include rental residential properties, commercial properties, and vacant land, and investors can also mix and match property types. For example, you can sell a commercial office building and use the gains from that sale to buy a series of single-family homes. As long as you use those single-family homes as rental properties (NOT as your primary residence), this will qualify as a 1031 exchange, and you can defer payment of any taxes owed on the gain from the sale of your original property.
The timing of a 1031 exchange can also vary. You can simultaneously “swap” one property for another, or you can sell a property and acquire a like-kind property later on; this latter option is more complicated but also offers more flexibility and time for you to find the right property.
In most states - including California - you can also defer state tax when you do a 1031 exchange. The California Ordinary Income Tax (at the time of writing this article) ranges from 9.3% to 13.3%, so a 1031 exchange will allow you to delay payment of that percentage of the gain from your property sale.
So is a 1031 exchange the right real estate investment strategy for you?
First, make sure you understand what types of properties qualify. You cannot exchange a primary residence - the house that you live in - or a vacation home. These types of properties are not considered investment properties in the eyes of the IRS. An exception to this rule is if your primary residence has been used as a rental property for a period of time before the sale, or if it has been used partially for business purposes, such as a home office or duplex, half of which has been rented. In these cases, it may be possible to combine a 1031 exchange with other sections of the IRS tax code in order to defer capital gains tax on the sale of the home.
Second, make sure you have the right team, right away. A 1031 exchange will generally not take any longer than a traditional real estate transaction, but it’s important to engage with a 1031 exchange company as soon as you are in escrow on the property you are selling. There is a strict timetable that needs to be followed to ensure that your 1031 exchange is handled properly, and an expert 1031 exchange company will be best able to walk you through all of the necessary steps. In the eyes of the IRS, 1031 exchange companies act as “qualified intermediaries” that ensure the security of exchange funds, prepare all exchange documents, and generally make sure that the exchange is handled smoothly - and legally.
Third, make sure that your real estate agent knows you are planning on a 1031 exchange and that he/she includes a “1031 exchange clause” in both the purchase agreement and the sale agreement. Discuss the important deadlines you will have, and make sure you have a foolproof strategy for meeting your goals.
Currently, you have 45 days after selling your investment property to identify possible replacement properties. There are specific rules about how many properties you can identify, and your exchange company and your Buyer’s Agent can help you with those. Then you have 180 (from the sale of your investment property) to close on your replacement property(ies).
1031 exchanges can be powerful investment and wealth-building tools, if used correctly. As with any investment strategy, it’s important to educate yourself and work with a team of professionals who know the subject inside and out - a trusted 1031 exchange company and an experienced San Diego Exclusive Buyer’s Agent who knows the city’s investment property scene. Contact me with any questions you may have about purchasing an investment property in San Diego.
Exclusive Buyer Agentsdo not list homes for sale and never represent sellers. They have no "inventory" to try to sell you. They can represent you in purchasing any home. They are specialists at representing buyers only on the buyers' side of the transaction. Exclusive Buyer Agents work to get buyers the best price and terms when they buy a home.
If you are looking for a 1031 Exchange Buyer's Agent in San Diego to purchase an investment property within 90 days, contact Justin Gramm to hire an agent on your side of the transaction. More about Justin Gramm on Google+. Call Justin at (858) 437-2662 or E-mail.