What is 1031 Exchange?
A 1031 exchange is a tax-deferment strategy useful in real estate transactions that occur throughout North, Central, and South Florida. 1031 exchange rules allow real estate owners in expensive markets to exchange properties for cash-flow properties elsewhere. The 1031 name comes from section 1031 of the United States’ Internal Revenue Code, which is where this type of transaction is defined.
Specifically, a 1031 exchange (or like-kind exchange) allows the property owner to defer paying capital gains taxes on the sale of investment real estate provided another like-kind property is purchased with the profit from the sale. This is one of the points that must be considered in the process of buying and selling real estate property- often commercial but at times residential as well.
What is Like-Kind Property?
The term “like-kind” indicates that the replacement property must be of the same nature or character as the original property even if they vary as to grade or quality. In practice, by 1031 exchange rules, almost any two pieces of real estate can meet this definition. Certain personal property is allowed by the Internal Revenue Code. The property owner must have held the relinquished personal property for rental, investment or use in his/her trade or business, and must have the intent to hold the like-kind replacement personal property for rental, investment or use in his/her business. Personal property not held for rental, investment, or use in the property owner’s trade or business is not considered to be qualified use personal property and will not qualify for 1031 Exchange treatment.
When is a 1031 Financing/Exchange Beneficial?
In normal circumstances, the seller of an investment property pays capital gains tax upon the sale. This holds true even if he/she was not the original purchaser. This can cost the seller a considerable amount money, maybe even more than what he/she realizes from the sale of the property. Local title agencies in Central Florida help to ensure all terms are met and to help determine if a 1031 Exchange is the best option for a particular situation.
Assuming the seller owns a rental property that has appreciated significantly in value, he/she can turn that loss into a profit by engaging in a 1031 exchange. At least in the short term, the seller avoids capital gains by trading one commercial property for another of comparable value. Someday, presumably, the investor will cash out and pay taxes, but he/she controls when that happens. Meanwhile, it is possible to trade properties without encountering a sudden tax obligation by implementing this exchange option.
Additionally, property owners/investors have the opportunity to invest their monetary savings into properties that generate additional cash flow and/or are easier to manage. Your local title agencies in Florida can help ensure everything goes as smoothly as possible.
Are you in the process of refinancing your current home? Do you need help with home title services? If you have any questions or needs, contact our Attorneys to find out how we can help you easily navigate the real estate purchasing/mortgage process and how we can provide you with the peace of mind you deserve. True Title is a company setting a standard of excellence industry-wide. We at True Title have been committed to excellence in customer service since 1998.
What Rules Govern 1031 Exchange?
In addition to the basic requirement that the two properties be of the same nature or character, a number of 1031 exchange rules control if and how a like-kind exchange can take place with property title transfers.
Both the new purchase price and new loan amount for the replacement property must at least equal those of the original property. Ideally, the net market value and equity of the replacement property should at least equal those of the original property. If they do not, the Internal Revenue Service does not allow an investor to defer 100% of the tax.
Specifically, if the sale price of the original property exceeds the purchase price of the replacement property, the investor pays capital gains tax on the difference. That difference is commonly called the “boot,” and investors may decide such a partial 1031 exchange is acceptable when they want to generate additional cash-flow and they do not mind paying additional taxes on the transaction.
The name on the title to the original property and the associated federal tax return must be the same. The one exception is in the case of a Single-Member Limited Liability Company. In these cases, 1031 exchange rules consider the exchange to be a pass-through to the single member of the LLC. This means the single member of the LLC may purchase the property from the Single-Member LLC in his/her individual name and pursue property title transfer.
There is a window of 45 days after the closing for the property owner to identify up to three like-kind properties regardless of value, or the property owner may identify four or more like-kind properties provided the total value is 200% or less of the value of the original real estate sold.
Finally, the 1031 exchange must be completed with the local title agencies no later than 180 days after: a) the exchanged property is sold or; b) the due date of the income tax return (with extensions) for the year in which the original property was sold, whichever comes first.
What are the Different Types of 1031 Financing/Exchange?
THERE ARE FOUR TYPES OF 1031 EXCHANGE
A simultaneous 1031 exchange is one in which the original and replacement properties close on the same day. Such a like-kind exchange can occur through a simple trading of deeds, the use of a third party (the so-called accommodating party) to facilitate a simultaneous exchange, or exchange through a third-party who manages the process as a whole.
It is important to understand that this kind of 1031 exchange absolutely must be simultaneous. If there is even a brief delay, then it is not a 1031 exchange, and the tax savings are forfeited.
Delayed 1031 exchanges are the most common types seen with title companies today. In these instances, the investor disposes of the original property prior to the acquisition of the replacement real estate.
This option makes the Exchangor responsible for marketing the original property, finding a purchaser, and executing a sale and purchase agreement. He/She then hires a third-party Exchange Intermediary to initiate the sale of the original property and hold the money in a binding trust while the Exchangor finds a like- kind property to purchase.
A Reverse 1031 exchange is one in which the investor acquires the replacement property before identifying the original property.
Simple in theory, these forward exchanges, as they are also called, present a couple of potential problems. First, they must be cash only, and some lenders do not offer loans for reverse exchanges. Also, the investor must decide which of his properties he will relinquish, and if the closing does not happen within 180 days, the exchange is forfeited and any property title exchange is also forfeited.
The fourth kind of 1031 exchange is a construction/improvement exchange. This kind of like-kind exchange enables a person to use the exchange equity to make improvements on the replacement real estate. In other words, tax-deferred money is used to improve the replacement property while an intermediary holds onto the property and the property title.
1031 exchange rules set three conditions for a construction/improvement exchange:
- The entirety of the exchange equity must be applied to improvements or to a down-payment by the end of the 180-day timeframe.
- The property must still be essentially the same as that previously identified, only with all of the improvements in place.
- The replacement property must be of equal or greater value than before. Only then can the local property title pass back from the intermediary to the investor.
Being a licensed Florida title insurance company, True Title boasts a highly skilled staff that is ready, willing and able to assist you with your 1031 Exchange and any other property title transfer needs you may have. When it comes to local title agencies, we are the name more people trust! Whether you are in Tallahassee, Orlando, Miami, or anywhere between, we are here to help. Give us a call now so we can get started – (877) 785-8792.
Are you in the process of refinancing your current home? Do you need help with home title services? If you have any questions or needs, contact our Attorneys to find out how we can help you easily navigate the real estate purchasing/mortgage process and how we can provide you with the peace of mind you deserve. True Title is a company setting a standard of excellence industry-wide. We at True Title have been committed to excellence in customer service since 1998.
