At 1031 Equity Exchange, LLC, we take a lot of the guesswork out of executing a 1031 Exchange. Each member of our experienced team is well-versed in all aspects of the law, and can help you properly execute a 1031 Exchange without exposing you to the risk of financial penalties.
Although we are happy to guide our members through every step of the process, we also understand that no person likes to make an investment without having some knowledge base to draw from. For that reason, we have provided explanations of some key terms and concepts that should further enhance your understanding of how 1031 Exchanges work.
If you have any further questions regarding the 1031 Exchange Rule, please do not hesitate to contact us.
WHAT IS THE 1031 EXCHANGE RULE?
As mentioned earlier, there are a number of rules and regulations to follow when executing a 1031 Equity Exchange. Failing to adhere to these guidelines can result in severe financial penalties and a loss of the tax deferral advantages conferred by a properly executed exchange.
A commercial real estate transaction only qualifies for a 1031 Exchange if the following conditions are met. Often, these conditions are referred to as the 1031 Exchange Rule:
- The properties involved in the transaction must be like-kind.
- Both properties must be held for productive use in business or trade or for investment purposes.
- Proceeds from the sale of a relinquished property must go through the hands of a qualified intermediary, or QI. Any proceeds that are handled by either you or one of your agents is subject to taxation.
- All equity from the sale of the relinquished property must be reinvested in a replacement property. Any cash proceeds retained from the sale that are not applied to a replacement property are subject to taxation.
In addition to the above rules, the replacement property in a 1031 Exchange must be subject to an equal or greater amount of debt than the relinquished property. If not, you will be required to pay additional fees to offset the lower amount of debt on the replacement property.
At 1031 Equity Exchange, LLC, our nationwide network of investors makes it easy to find the replacement property that satisfies both your investment goals and the 1031 Exchange Rule.
WHAT DOES LIKE-KIND PROPERTY MEAN?
In order to qualify for the tax benefits of a 1031 Exchange, both the relinquished property and the replacement property must qualify as like-kind properties.
Before determining whether the properties in question are like-kind, you must first ensure that both properties are eligible for a 1031 Exchange. To be valid for a 1031 Exchange, a property must be held for investment purposes or used in your trade or business. If a property is not held for investment or used in your trade or business (i.e. personal properties, vacation properties, etc.), it cannot be used in a 1031 Exchange.
- Properties Held For InvestmentAny property or asset that you hold for investment purposes – such as rental properties or any property that you lease – or for capital appreciation is considered a property held for investment purposes. These properties do not need to produce a tangible income or growth in value; they merely need to be held for one of these purposes. Properties held for investment purposes are eligible for 1031 Equity Exchanges.
- Properties Used in Your Trade or BusinessAny property or asset used in your trade or business also qualifies for a tax-deferred 1031 Exchange. These properties include commercial real estate used in business (such as office buildings) and other properties related to your business interests.
WHAT ARE THE DIFFERENT KINDS OF 1031 EXCHANGES?
For commercial real estate, there are three types of exchanges: Delayed Exchanges, Reverse Exchanges and Improvement Exchanges. Although the core principles behind each type of exchange are the same, the procedure is different for each.
Delayed Exchange: A Delayed Exchange is the most commonly executed 1031 Exchange. In a Delayed Exchange, the property owner sells (or “relinquishes”) the property he owns and then replaces (or “exchanges”) it with a new property. The property owner, or Exchangor, has 45 days after closing the relinquished property to identify a replacement property and a total of 180 days to close on the property.
Reverse Exchange: A Reverse Exchange is the opposite of a Delayed Exchange. In a Reverse Exchange, the investor is able to acquire a replacement property and exchange their existing property for it at a later date. In essence, a Reverse Exchange allows investors to strike while the anvil is hot. You do not need to worry about relinquishing your existing property before you purchase a new property. You can wait to sell your existing property until the real estate market is more advantageous.
Please note: at 1031 Equity Exchange, LLC, we advise all of our clients to focus on executing Delayed Exchanges. Reverse Exchanges are rare, costly, and involve double escrows and other complications. Although we are happy to conduct a Reverse Exchange for any client that asks, we always recommend that our clients pursue other avenues first. Fortunately, our nationwide network of motivated buyers and sellers makes it easy to find the commercial real estate property that meets your investment needs.
Improvement Exchange: Improvement Exchanges are the least common form of 1031 Exchange. In an Improvement Exchange, the Qualified Intermediary acquires the title to a replacement property on behalf of the Exchangor. Improvements are made on the property until it is transferred over to the Exchangor. As mentioned above, we recommend that our clients focus on Delayed Exchanges.