1031 Exchange

San Diego 1031 Exchange

A 1031 Exchange is a complicated but useful real estate transaction that allows individual investors and companies to swap one type of asset for another. 1031 Exchanges get their name from Section 1031 of the Internal Revenue Code that covers such transactions. Assets in this case can refer to anything from stocks, bonds, machinery, equipment and even real estate.

Why do such an exchange? Tax deferral. An investor will normally pay between 15% to 20% taxes on any financial gains made from selling an investment property. In instances where an investor is selling one property and using the proceeds from the sale to buy another property, a 1031 Exchange is a useful way to defer or even eliminate such taxes.

Obviously 1031 Exchanges are not for everybody, but for instances where they are applicable they should be considered as an effective means of deferring capital gains tax on the sale of investment assets.

Rules Governing a San Diego 1031 Exchange

  • The property you swap out and the new property you acquire as part of a 1031 Exchange must both be investment properties. Primary residences cannot be used in a 1031 Exchange. The definition of investment property is quite broad, though – a rental property you own where you reside in one of the units may be considered an investment property for the sake of a 1031 Exchange.
  • Depreciation Recapture applies to 1031 Exchanges. Any investment property used in a 1031 Exchange that is considered depreciable for tax purposes (this can be anything from real estate to office equipment, farm machinery or factory equipment) will fall under the Depreciation Recapture rule and will be taxed as ordinary income. One strategy for avoiding Depreciation Recapture would be to swap only like kind assets in a 1031 Exchange i.e. one undeveloped plot of land for another undeveloped plot of land. If, for example, if you swap a 10 acre plot with a building for a 10 acre plot without a building, the tax deductions you have claimed over the years from depreciation of the building will be recaptured as ordinary income.
  • Assets swapped in a 1031 Exchange must be like-kind. You cannot swap stocks and bonds for real estate, or you cannot swap paintings for office equipment. All kinds of property, developed and undeveloped land are considered like kind and qualify for 1031 Exchanges.
  • The purchase price of the property you obtain has to be equal value or higher in value than the property you relinquish.
  • Any profits earned in the sale of the relinquished property is liable to be taxed as capital gains

Timeline for a 1031 San Diego Exchange

In the real world a 1031 Exchange is not as simple as swapping your property for another similar property. Usually 1031 Exchanges involve a third party who will facilitate the swap through what is known as a delayed exchange. Delayed exchanges make it practical to relinquish your property and obtain a suitable replacement in a reasonable time frame.

The normal course of action is this: you relinquish your property to the intermediary, who then sells it. You now have 45 days to designate a replacement property. Only when the replacement property is designated in writing to the intermediary can you proceed to the next step of the 1031 Exchange.

The next step involves closing on the replacement property, which you have to do within 180 days of the intermediary selling your relinquished property. The 45 days you have to designate the replacement property runs concurrently with this 180 day limit. For example if you designate a replacement property 20 days after the intermediary sells your old property you now have (180 – 20) 160 days to close on the replacement property. Once again, you cannot take more than 45 days to designate a replacement property.

Want to Structure a 1031 Exchange?

As complicated as it may appear on paper, many investors successfully employ 1031 Exchanges to greatly reduce or eliminate their tax burden from the sale of investment properties. I work with trusted 1031 Exchange specialists who will help structure the best possible deal for you. Get the most from your investment dollar – call me today and see how I can help!