1031 Exchange, Some Basics
What is the 1031 or Like-Kind Exchange?
The 1031 or Like-Kind exchange is a tax deferment process for investment properties. Essentially when an investor sells their property and exchanges it (buys a new one) there is a specific process that can be done to defer any taxes on capital gains. This process is highly regulated and takes careful planning. When the initial investment property is sold, the seller has 45 days to designate a new property/properties while the proceeds of the sale sit in escrow with a third party. The purchase and sale of the new property must then be completed with 90 days and special accommodations made with the closing attorney’s office and escrow holder. If the steps are not completed exactly as required, the seller may be subject to the capital gains tax they are trying so hard to avoid. It is very important to ensure all parties comply with the strict timeline.
What types of properties can be used?
Only investment properties can be used in the 1031 Exchange, thus primary residences are out. This process is very common in California and with big time investors, but that isn’t to say that it cannot be done anywhere or with smaller scale investments. However the third party escrow companies do carry a fee, so there are costs incurred that should always be considered.
I’ve just sold my investment property; can I buy a new one with the exchange?
Unfortunately, if a property has not been designated prior to closing that it is going to be exchanged, it is not possible after-the-fact. The step of having the proceeds of the initial never touch the hands of the seller is crucial to the entire process, thus the third-party escrow company is involved.
If you do have an investment property that you are looking to exchange the key component here is planning. Having a set strategy that is in line with the regulations is paramount to avoiding unanticipated taxes, which would make the whole process moot. Although these are basic points on how it works, it is important to research and plan accordingly if this is the next step for your investment property.