1031 Exchange Rules 1031 Exchange rules: How to increase monthly income and defer taxes

Understanding 1031 Exchange rules

A well-thought-out tax and investment strategy can be the most profitable tool in an investor’s toolkit. If you own or are considering selling an investment property that will net a large profit (and therefore a substantial tax bill), you could benefit from a 1031 Exchange. Capital gains taxes can range anywhere from 15% to 30%: by using the 1031 Exchange, investors can defer these taxes for as long as needed and reinvest into a property with better return prospects. While 1031 Exchanges can be very favorable to real estate investors, it’s not always the most intuitive to execute. Below, we’re breaking down 1031 Exchange rules to help you increase your monthly income (without paying more in taxes!).

What is a 1031 Exchange?

Named after section 1031 of the U.S Internal Revenue Code, the 1031 Exchange, or ‘like-kind’ exchange as it is also called, is used to postpone capital gains tax on the sale of an investment property or business by using the proceeds to purchase a replacement property. 

Proceeds from the sale must be transferred to a qualified intermediary, who then transfers them to the seller. The qualified intermediary is a company or individual that facilitates the exchange by holding the funds of the transaction until they can be transferred to the seller of the ‘like-kind’ replacement property.

A ‘like-kind’ property can refer to a broad range of property options open to the investor, with vacant land, industrial property, commercial buildings, and residential buildings all exchangeable as long as the properties have been held for a minimum two-year ownership.

1031 Exchange Rules - Timeline

What properties qualify?

Because each case is unique, it is essential that you consult a tax professional to discuss if this solution suits you prior to lodging a claim. Only property held for either investment or business can claim: personal residences, as well as vacation or second homes that are not held as rental properties, cannot claim. 

If your property falls under the investment or business use and you do qualify for a 1031 Exchange, there are a number of rules you must follow in order to swap your property for a ‘like-kind’.  

Three-Property Rule:

In this case, you may identify up to three different properties as potential purchases within a 45-day identification period, with no restrictions on the total fair market value of the properties.

The 200% Rule:

This rule allows you to identify an unlimited number of properties as long as the total fair market value of the properties combined does not exceed 200% of the total value of all relinquished property in the exchange.

The 95% Rule:

This rule allows you to identify as many alternative properties as needed, as long as you acquire properties valued at a minimum of 95% of their total prior to the end of the exchange period.

Reverse 1031: 

A reverse exchange is essentially the same transaction in reverse: in this case, the second investment property has been purchased before the sale of the first. Sometimes, this process may involve an “exchange accommodation titleholder” who holds the new property for a maximum of 180 days while the sale of the old property takes place. 

1031 Exchange Property Qualification

Overcoming the speed-to-market challenge

The real trick with the 1031 Exchange comes down to effective time management. This is because the investor must either identify or close on a new purchase property within 45 days of the closing transfer of the sales property and purchase the new asset within 180 days (including public holidays and weekends). The investor must not exceed this non-negotiable time limit, as doing so risks losing their claim.

In the red-hot 2022 real estate market, a 1031 Exchange can be difficult to execute, as inventory is tight and most investors have stringent profitability criteria for a replacement property. Bidding against many buyers for a limited pool of options within this narrow 45-day window can add an extra layer of difficulty to this process.

Our Rabbu Marketplace can be a huge asset when applying for a 1031 Exchange, as you need a fast turnaround when purchasing another property. Within our Marketplace, investors can opt-in to Deal Alerts where they tell us their personalized investment criteria, allowing us to source the market to find investment properties that align with the investor’s goals specific to purchase price, property type, market, and returns then sending these curated deal alerts directly to the investor’s inbox. 

rabbu deal alerts set up

By being able to adjust your settings and receive personalized deal alerts right to your inbox, you can cut down the search time and find a valuable investment property that may provide better returns in the time needed to submit a 1031 Exchange.  

By eradicating the challenge of sorting through public listing sites and comparing and analyzing findings from different sources, this all-in-one app assists investors by simplifying the acquisition of profitable investments. Finding the right property at the right time can have a huge impact on your future wealth growth, as Section 1031 Exchanges can help you receive a favorable tax bill–which, in turn, can help you put that money into a stronger asset that can turn higher profits on your investments. 

Seem complicated? It truly is simpler–and more profitable–than you think. If you’d like to figure out how Rabbu can help you make the most of your investment, get in touch with us below!

 

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