1031 Exchange Intermediary
When investing in real estate, savvy investors know that a 1031 exchange can be a powerful tool. Also known as a like-kind exchange, a 1031 exchange allows investors to defer capital gains and depreciation recapture taxes when they sell property held for investment or business purposes and reinvest the proceeds into a similar property.
By deferring the tax, investors can use the additional capital to purchase more real estate, further increasing their potential profits. And because the 1031 exchange provisions are codified in the Internal Revenue Code, investors can be confident that they are taking advantage of a legal tax-planning strategy.
Here's how it works: let's say you purchased a property for $50,000 with a $25,000 loan. After ten years, you sell the property for $150,000. The structure is valued at $25,000 and was depreciated yearly by $9,091. Additional selling expenses include a realtor sales commission of $13,500. Therefore the total capital gain from the sale is $95,591.
If you initiate a 1031 exchange, the total tax-deferred from the sale, including recaptured depreciation and federal capital gains, is $15,248. So instead of walking away from the closing with $96,252 in after-tax equity, perform a 1031 exchange by reinvesting $150,000 or more in a new property. By doing this, you will continue to benefit from the $15,248. Essentially, 1031 loans are interest-free loans that provide cash infusions for new ventures.
Whether you are looking to defer taxes on the sale of a rental property or hoping to capitalize on the 1031 exchange to upgrade your investment portfolio, it is important to partner with a qualified intermediary.
A qualified intermediary is a person or entity that facilitates the 1031 exchange process by holding the proceeds of the sale in escrow until the replacement property is identified and purchased. The role of the qualified intermediary is critical, as they must be independent of the taxpayer to avoid triggering the tax. When choosing a qualified intermediary, select a reputable firm with extensive experience in 1031 exchanges.
Why a 1031 Tax Exchange?
There are several different taxes applied to property sales, which can add up to a lot of money if you are buying and selling real estate on a regular basis, or even if you just have a one-time sale. Whenever you are thinking about selling real estate, the benefits of 1031 tax deferred exchange should be considered:
This is generally the only option to postpone (and in some cases, eliminate) taxes owed on property sales.
The money you save by not paying taxes can be reinvested in new property, so you have more of your funds working for you.
Depreciation recapture is postponed until a later date or eliminated altogether.
If you are frequently acquiring and disposing of properties as a way to maintain a diversified portfolio, you won’t have to spend your hard-earned money on taxes with every transaction.
1031 Exchange Types
There are different 1031 exchange types, each with its own benefits and drawbacks.
The most common type of exchange is the Forward Exchange, in which the taxpayer sells their investment property and then replaces it within 180 days. This exchange is relatively simple to execute and provides the taxpayer with a wide range of options for replacement property. However, it can be difficult to find a suitable replacement property within the 180-day timeframe, and the taxpayer may be forced to accept a less desirable property than their original investment.
Another type of exchange is the Reverse Exchange, in which the taxpayer purchases the replacement property before selling the relinquished property. This exchange gives the taxpayer more time to find a suitable replacement property but requires a greater upfront investment. In addition, Reverse Exchanges are much more complex than Forward Exchanges and are often subject to additional restrictions from the IRS.
Less common exchanges include International Exchanges, Build-to-Suit Exchanges, and Leasehold Improvement Exchanges. These exchanges can benefit taxpayers with specific needs, but they are often more difficult to execute and may be subject to additional limitations from the IRS.
Here is a brief overview of the different types of 1031 exchanges:
- Forward Exchange - In this scenario, the taxpayer sells their property and then replaces it with a new one.
- Reverse Exchange - Taxpayers purchase a replacement property before selling the current property. An EAT "Exchange Accommodator Titleholder" is required to accomplish this.
- International Exchange - These include exchanges of property outside the United States and its territories.
- Build-to-Suit Exchange - An individual sells their property and uses the exchange funds to purchase and improve a parcel of land.
- Leasehold Improvement Exchange - Like in a Build-to-Suit Exchange, the proceeds of the relinquished property are used to improve the taxpayer's existing property.
Choosing the right type of 1031 exchange depends on several factors, including the nature of the investment property, the desired replacement property, and the timeframe for completion of the exchange. Taxpayers should consult with a qualified 1031 exchange specialist to ensure that their exchange meets all IRS requirements.
Properties That Qualify for 1031 Exchanges
It's important to note that not all property is eligible for a 1031 exchange. To qualify, the property must be held for investment or used in a trade or business. For example, personal residences and vacation homes are not eligible for 1031 exchanges. In addition, investors must exchange the property for "like-kind" property, which is defined as a property of the same nature, character, and purpose.
Below, we will examine some of the most common types of property that are eligible for 1031 exchanges:
- Commercial Real Estate - Commercial rental properties, office buildings, warehouses, retail centers, and other similar properties.
- Residential Real Estate - Residential rental properties, duplexes, triplexes, four-plexes, and other similar properties.
- Agricultural Property - Farmland, ranches, orchards, and other similar properties.
- Conservation Easements - Interests in land that is held for conservation.
- Mineral Rights - Rights to extract minerals from a piece of property. Oil, gas, mineral, and ditch rights all qualify as mineral rights. Royalties also qualify.
- Tenants in Common (TIC) or Delaware Statutory Trusts (DST) - Interests in real property are divided into undivided fractional ownership interests.
While this list is not exhaustive, it provides a good overview of the properties eligible for 1031 exchanges. If you're unsure whether your property qualifies for a 1031 exchange, it's always best to consult a qualified 1031 exchange services provider.
Work With the 1031 Exchange Experts
To facilitate a 1031 exchange, it is required to utilize the services of a qualified intermediary (QI) – also known as a facilitator or accommodator. As a QI, we are the entity that acts as the middleman in your exchange, providing the paperwork, oversight, escrow services, and expertise necessary to assure that the exchange qualifies as an exchange under Section 1031 of the Internal Revenue Code. Even though a 1031 exchange can be a complicated process, an exchange using a good QI can become a simple process and feel surprisingly like a standard sale. In order to reduce the amount of scrambling you may go through at closing, it’s a good idea to get with your QI before your closing is scheduled to make sure everything is in place for a smooth closing. That being said, we also have a great turnaround time for those last-minute exchanges!
In a 1031 exchange, an exchanger cannot take physical possession or “constructive receipt” of the money resulting from the sale of your property. We take this part of our role very seriously. In order to keep exchange funds secure, our clients find comfort in our process. We use a Qualified Escrow Deposit Agreement by which 1031 exchange funds can not leave the FDIC-insured bank account unless wired to a bonafide real estate closing and the exchanger signs to release funds.
Although there’s a wealth of information to be found on our site, we invite you to contact us so that we can answer any questions and provide you with any direction that you need. We don’t want to just be your qualified intermediary – but your 1031 advocate. We love the 1031 industry and we’d love to earn your business.
When you are ready to begin your 1031 exchange, we are here to help, with some of the lowest fees in the country, starting at just $695. We can assist you in complying with current law, protecting your investment to ensure tax deferment, and ensuring that funds remain safe while your transaction is processed. Don’t risk being subject to capital gains taxes. Contact us today to learn more about the 1031 exchange process and how it can benefit you.
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