Section 1031 of IRC, widely known as 1031 exchange, lets investors defer up to 100% capital gains tax on swapping an income-producing asset with a like-kind property. Tax-deferred exchanges provide a unique opportunity to diversify your investment portfolio and defer taxes on real estate sales.
What is a 1031 Land Exchange?
Any property maintained for productive use in a trade or business or investment is eligible under 1031 land exchange. Although the 1031 exchange process can be full of technicalities and require some numbers-crunching to ensure that one is making the best decisions for oneself, the basic concept is simple. One directly locates and purchases replacement property equal to or greater in value than the land or property one has sold.
Once you’ve consulted with your advisors and determined that exchange makes sense, your primary tasks will be to find a buyer for the property you want to sell and locate the property you want to buy. One cannot trade partnership shares, stocks, bonds, notes, certificates of trust, or other identical items. An investor cannot exchange investment property for a personal residence, property in a foreign country, or “stock in trade.” Houses constructed by a developer and offered for sale are stock in trade. If an investor buys “fixer-uppers” and trades them as soon as they are developed, the properties can be regarded as stock in trade and may be disqualified for a 1031 Exchange.
If an investor tries to exchange hastily after a property is acquired or exchanges many properties during a year, the investor may be judged as a “dealer,” and the properties may be perceived as stock in trade. Anyone dealing with stock in trade is called a dealer and are ineligible to exchange their real estate unless they can demonstrate that it was acquired and held strictly for investment. The guidelines around what constitutes being a dealer are unclear.
What does not qualify for a 1031 land exchange?
Any property maintained for productive use in a trade or business or investment is eligible under 1031 land exchange. The tax code prohibits some property explicitly, even if the property is utilized in trade or business or for investment. These excluded properties generally involve bonds, notes, stocks, securities, and interests in partnerships.
Any property held “primarily for sale” is also prohibited. This excluded property would incorporate a business inventory. For real estate, it indicates property purchased with the intention to sell it, such as a fixer-upper or vacant land to be improved into a house. An investor who “converts” residential properties, or a private developer, may be classed as a dealer.
A primary residence normally does not pass for an exchange because it is not utilized in a trade or business or investment. If any portion of the primary house is utilized in a business or trade or for investment may qualify for a 1031 Exchange.
How to invest in 1031 Land Exchange?
Starting an exchange begins by calling an Exchange Facilitator. Prior to making the call, it will be convenient if the investor has details regarding the parties involved in the transaction at hand (for example, names, addresses, phone numbers, file numbers, and so on). In the telephonic conversation, the exchange coordinator will pose questions about the property being relinquished and any intended replacement property. The fundamental discussion will differ from company to company for the amount of particular requested.
Facing restraint while identifying land replacement is a puzzling task. To meet that:
As an Exchanger, you are expected to provide an “unambiguous description” of the implied replacement property on or before the 45th day after selling the old property. A legal description or property address will be needed. If your intention is to identify or purchase multiple properties, the following guidelines should be observed:
-Identify a maximum of three properties irrespective of the value with the intent of acquiring at least one.
-Identify more than three properties with a total amount, not exceeding 200% of the market value of the relinquished property.
-Identify any number of replacement properties with a total value exceeding 200% of the relinquished property, knowing that 95% of the total market value of all properties identified must be acquired.
A common question investors pose is whether a 1031 Land exchange involving various lands can be executed at the same time?
Multiple 1031 Land Exchange
The number of properties an investor is exchanging in or out of (1 property into 5, or 3 properties into 2) doesn’t matter until the properties go across or up in value, equity, and mortgage. The only concern with multiple 1031 land exchanges is adhering to the allotted time period.
Suitable 1031 replacement options –
One of the quickest ways to close your 1031 exchange is to invest in DST properties. DSTs are pre-packaged investment options that qualify for 1031 exchanges. Using a DST 1031 exchange, you can invest your sale proceeds in a DST property and defer capital gains tax. If you want to get rid of landlord responsibilities, investing in NNN properties will be beneficial for you. Triple net or NNN lease is an agreement that requires the tenant to pay operating expenses, whereas the landlord enjoys monthly income without any liabilities.
Section 1031 provides you an opportunity to exchange a non-performing asset for a high income-producing real estate. However, 1031 exchanges have an extremely complex process in nature, and it’s recommended that you seek guidance from 1031 experts or tax advisors.