What is a 1031 Exchange?
The 1031 Exchange is useful to anyone who already owns property and wants to purchase a replacement property. Without a 1031 exchange, a property owner that sells their property must pay taxes on the gains made from the sale. However, if the property owner wants to purchase another property within 180 days of the sale, they can defer the tax in a 1031 Exchange.
In a 1031 exchange, all of the gains made from the sale of your property can be used in your next property investment. It’s almost as if you’ve received a loan from the government to purchase your next property. If you use a Reverse 1031 Exchange, you can purchase the new property first and then sell your original property afterwards. Of course, this also is under strict time limits. Finally you can use the amount that you would have been taxed to build onto your new property and make improvements to it.
An important thing to note is that the replacement property must be the same value or greater than your original property. You are not able to turn your “would-be tax” into cash. It must be reinvested into your next property. The gains instead are placed into an exchange account in the interim of purchasing your next property.
What if the next property I purchase is of lesser value?
There is an option to purchase more than one property and therefore match or exceed the value of your current property. When using this option, you must meet one of these three cases.
1. You can simply purchase three properties without any regard to their value.
2. You can purchase as many properties as you want, but the total value cannot be anymore than twice the value of the original property.
3. You can identify an unlimited number of properties that you would like to purchase, but the aggregate of the properties that you finally do purchase must be at least 95% of the aggregate of all of the properties identified.
Is this isolated to only real estate?
No, the 1031 exchange can theoretically include personal assets such as machinery, basic resources, etc. Sometimes this can be done in a multi-asset exchange where there is the transition of both real estate and personal property. The exchange of such items must be of “like-kind.” So that means if you’re selling a nightclub, you’re also acquiring a space suited for a nightclub. The personal property inside these buildings, such as tables, must be matched in the exchange in order to receive the benefit. If you take your time and plan it all out, it can be very rewarding.