What Is a 1031 Exchange and How Does It Work?

What Is a 1031 Exchange and How Does It Work?

In 2019, 36% of the US 122.8 million households were connected to renters. It might surprise you that most rental properties are owned by real estate investors who only own a few properties. 

With so many renters and those statistics likely to grow, it's not surprising the number of real estate investors looking to expand their portfolios. 

If you're hoping to improve the quality of your real estate holdings, you might be interested in a 1031 exchange.

A 1031 exchange for real estate allows you to sell a property and buy another without paying capital gains taxes. 

As an investor, avoiding additional taxes at the end of the year is always desirable. Read on to learn more about how 1031 exchanges work and why it might be right for you. 

What Is a 1031 Exchange?

A 1031 exchange, called a like-kind exchange by the IRS, allows you to take capital gains from selling one property and invest it in another like-kind property.

While the rules are strict and complicated, the benefits of delayed capital gains make it worth it. 

As a real estate investor, there are several reasons you might opt to work through a 1031 exchange. 

You're selling one property to upgrade to a property with a better opportunity for profit. You might wish to buy into a more managed property with more units than what you currently own.

Some investors will use a 1031 exchange to reset depreciation, which is a key part of establishing the value of a property when you sell. 

How 1031 Exchanges Work

Understanding 1031 exchange rules are key to avoiding capital gains taxes. 

First, you must decide what property you're selling and what property you plan to buy. Remember, the rules say they must be like-kind, which means they must be similar but not necessarily the same quality or grade.

You will need to work with a qualified intermediary who will hold the funds from the sale of the first property until the sale of the property you're buying is finalized. It's important to follow the rules for who can be a qualified intermediary. 

When tax time comes around, you'll notify the IRS of the 1031 exchange using IRS Form 8824. This tells the IRS to not tax you on the capital gains achieved from the property sale since they were reinvested in the new property.

1031 Exchange Rules

There are some rules for the 1031 exchange to know about. 

Once your property gets sold, and the money is being held by the quality intermediary, you have only 45 days to designate a property you plan to purchase. The rules say there are several options under this rule for notification of what you plan to buy.

The other rule involving a strict time is the 180-day rule. This means you have only 180 days to close on the property you're buying with the capital gains from the sold property. 

Build Your Real Estate Portfolio With a 1031 Exchange

Using a 1031 exchange is smart way to grow your real estate portfolio and delay the property taxes along the way. 

If you have an investment property and need a property manager, we can help. Contact us today to learn more about management services in the greater Tulsa area. 

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