The 1031 tax-deferred Exchange provided in the IRS code is an extremely powerful tool for the deferral of the tax bill that the IRS will come knocking for when you sell your investment property. There are four main types of like kind exchanges that real estate investors can choose to execute. The types of exchanges are simultaneous exchange, delayed exchange, reverse exchange, and construction or improvement exchange. Any of these property exchanges will get you into a new property without having to pay a capital gains tax.
A simultaneous exchange is when the replacement property and relinquished property close the sale on the same day, making them simultaneous.
There are three general ways that a simultaneous exchange can take place.
- Complete a two-party trade, where the two parties exchange or “swap” deeds.
- A three-party exchange where an “accommodating party” facilitates the transaction in a simultaneous manner for the exchanger.
- Simultaneous exchange using a qualified intermediary who handles the entire exchange.
The delayed exchange is the most common type of exchange used by investors today. This is when the exchangor relinquishes the original property before he acquires replacement property.
Simply put, exchange the property you own first, and transfer the proceeds from the sale into the replacement property.
You will need to execute a sale and purchase agreement before the delayed exchange can begin. Once this has taken place, a third-party Exchange Intermediary can initiate the sale of the relinquished property and hold the proceeds from the sale in a trust for up to 180 days while the seller finds a like-kind property.
The delayed exchange allows an investor a maximum of 45 days to identify the new rental property and 180 days to complete the sale of their property. In addition to the numerous tax benefits, this extended timeframe is one of the reasons that the delayed exchange is so popular.
A reverse exchange is when you acquire the replacement property through an exchange accommodation titleholder prior to exchanging the property that is already owned. This type of exchange, simply stated means: Buy first, exchange later.
Reverse exchanges are not the most common as they need to be all cash. Banks generally won’t offer loans for reverse exchanges. Taxpayers need to choose which investment properties are going to be used for the exchange. Failure to close on the relinquished property during the established 180-day window results in forfeiture of the exchange.
There are two main differences:
- 45 days to identify “the relinquished property.”
- 180 total days (including the 45 days to identify) to complete the sale of the identified property and close the reverse 1031 exchange with the purchase of the replacement property
Construction or Improvement Exchange
The construction exchange allows the property owner to improve on the replacement property by using tax-deferred dollars to update the replacement property while held by a qualified intermediary for the remainder of the 180 day exchange period.
There are three requirements if they want to defer all of the gain (from the sale of the relinquished property) and instead use it as part of the construction or improvement exchange.
- The entire exchange equity must be spent on completed improvements or as down payment by the 180th day.
- The taxpayer must receive “substantially the same property” that they identified by the 45th day.
- The replacement property must be equal or greater in value when it is deeded back to the taxpayer. The improvements must be in place before the taxpayer can take the title back from the qualified intermediary.
I hope this article helps you as you navigate which type of 1031 exchange is the best for you. An extremely powerful tool worth utilizing. Keep in mind that 1031 exchanges can not be done with your personal property or primary residence, only an investment property like an apartment building or a business property. You can learn more in this article about 1031 exchanges, the exchange process and exchange rules here. At FNRP we believe that real property is the best investment. If you have any questions regarding 1031 exchanges or any real estate related questions, the team at First National Realty Partners is just a phone call away. We’re here to answer your questions and provide guidance about your investment opportunities. If you would like to know more about the benefits of private equity commercial real estate investing, please don’t hesitate to reach out. Our team is built with the best industry leaders, utilizing proven strategies that create great investment opportunities for you. Contact us any time when you are ready to learn more about the possibilities of investing in commercial real estate.
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