Did you know that you can swap one investment property for another without paying capital gains tax in Joplin? This process is made possible by Section 1031 of the Internal Revenue Code (IRC).
By taking advantage of 1031 Exchanges, investors may be able to build considerable wealth over time whether the investment properties are leased or not. This is because there is no limit to how many exchanges investors can make under the code.
With that said, Section 1031 has many moving parts that investors must understand prior to starting the process. In this article, we at Pro X Property Management will walk you everything you need to know in this regard.
What is Section 1031 of the Internal Revenue Code?
A 1031 Exchange is also commonly referred to as like-kind exchange or a Starker. Is a commonly used real estate term, but it is not covered by the landlord-tenant laws, but rather by the IRC. It’s basically a swap of one like-kind exchange investment properties for another with zero liability in regard to capital gains taxes as long as all requirements are adhered to.
The Internal Revenue Service doesn’t put a cap on how frequently an investor can use a 1031. In effect, you can roll over the gains from continuous real estate investments to another and while each swap may yield you a profit, you’ll only get to pay tax the moment you decide to sell for cash. This can be many years later.
Even then, the IRS will only require one tax payment at a long-term capital gains tax rate. Currently, the tax rate for long-term capital gains is either 15 or 20 percent depending on your income.
What are the Special Rules for 1031 Exchanges in Joplin?
For you to qualify for a 1031 Exchange, you’ll need to meet a few of requirements, they are as follows:
The Properties Being Swapped Must Be Like-Kind
In the real estate business, like-kind simply means investment properties that share the same nature or character, notwithstanding any differences they may have in grade and quality. The lease is also not relevent when considering a 1031 exchange.
So, you can exchange raw land for an apartment, or a strip mall for a ranch. The rules tend to be overwhelmingly liberal. It may also be possible to exchange one business for another but that is far less predictable.
1031 Exchanges are only reserved for businesses or investment properties. The provision may only apply for a former primary residence and a vacation home under certain strict conditions.
Abide by the Timing Rules
In an exchange involving swapping investment properties for others, the odds of finding properties that are exactly like yours with a landlord who wishes to trade for your property are slim.
It’s for this reason that the majority of exchanges are delayed. In delayed Exchanges, or Starker Exchanges, you’ll need to find a middleman (qualified intermediary) to facilitate the exchange for you.
Their role is to hold the funds involved in the transaction and then transfer them to the seller of the replacement property. At no point should you possess the funds involved in a 1031 Exchange.
As an investor, there are two key timelines that you must abide by when carrying out a 1031 Exchange.
45-Day Rule
Once the sale of the relinquished property is done, the intermediary will hold the cash on your behalf. Within 45 days of doing so, you must identify replacement properties. This you must do by designating the properties in writing to the intermediary, specifying the replacement properties you wish to buy.
You can identify three like-kind properties as long as you ultimately close on one of them. You may also be able to designate more if they meet certain IRC’s valuation tests.
180-Day Rule
The other timing rule is in regard to closing. The IRS requires that closing on the replacement properties be done within 180 days after sale of the relinquished property.
Please note that the two time limits run concurrently. As such, the clock starts to tick the moment when you have sold the relinquished properties. Suppose, for instance, you identify the replacement properties 30 days later. In such a case, you’ll only have 150 days remaining to close on it.
Are there any other types of 1031 Exchanges?
Besides a Delayed Exchange, there are 3 other types of 1031 Exchanges. They are as follows:
Reverse Exchange
This is the opposite of a delayed exchange. It occurs when an exchange purchase is for a replacement property and that property has not yet been sold. Exchangers cannot have ownership of the two properties simultaneously, IRC requires that an Exchange Accommodation Titleholder (EAT) be involved.
- Two-Party Simultaneous Exchange. This is the oldest of all 1031 Exchange methods. Here, two property owners reach an agreement to exchange their titles. While this method isn’t complicated, exchanges find it difficult to find properties equal or greater value.
- Improvement/Construction Exchange. This allows an exchanger to use some of the proceeds from a 1031 Exchange to make improvements to the replacement property. The 45- and 180-day deadlines still apply.
What is “boot” in a 1031 Exchange?
Boot refers to non-like like property that is received in a 1031 Exchange. In other words, it’s any sales proceeds that an investor receives from an exchange that isn’t re-invested in the acquisition of a replacement property.
If you sell a property for $250,000, for instance, and only reinvest $200,000 in a replacement property, the difference ($50K) would become boot. While boot may not stop a 1031 Exchange, you’ll be required to pay capital gains taxes on the amount.
Bottom Line
A 1031 Exchange is a wealth-building tool. As an investor, you can use it to obtain access to a property’s appreciation to increase purchasing power without any tax penalty. But Section 1031 of the IRC comes with many moving parts, which one can miss if not extra careful.
For expert help, Pro X Property Management LLC can help. We’ve been helping property owners in Southeast Kansas and Southwest Missouri since 2009. Get in touch to learn how we can help you enjoy the bliss of owning an investment property.
