A 1031 exchange is a powerful tool that allows an individual to save on taxes after the sale of a piece of real estate. This tax deferral program permits the investor to sell a real estate property and then reinvest the funds in a property of equal or greater value. Doing so allows the investor to keep more money in their pocket, and defer all capital gains taxes. Here's a quick overview on how the process works:
First, the properties involved in the exchange must be held for either business or investment purposes. This information is proven by tax returns, including rental income, depreciation records, and intent. It’s important to have this documentation in place in case of an audit.
There are also regulations in place for the new purchase. The new property must meet the reinvestment requirements. This means the new property must be of equal or greater value than the property that was sold.
Additionally, there is a strict timeline that the investor must uphold. The investor has 180 days to complete the exchange. This begins on the day escrow closes on the sale. Leonard explains that it’s important to work with an accommodator, such as his team. You also must reach out to your accommodator before escrow closing.
Finally, the IRS requires that the investor identify their purchasing plans on day 45. The investor must describe the property or properties they are planning to use as the replacement in the exchange.
For more on 1031 exchanges, check out my interview with 1031 exchange expert Leonard Spoto, and this podcast episode on the six rules of a 1031 exchange!