A 1031 exchange is an important tool that allows you to put off federal capital taxes by selling one of your properties and reinvesting the money in a like-kind property within a certain frame of time.
An important aspect of 1031 is its exchange timeline, a process that anyone wanting to do a 1031 exchange must pass through. So let’s look at what 1031 exchange is, its timeline and other important things you need to know.
What is 1031 Exchange?
1013 exchange, also known as a Starker or like-kind exchange, got its name from Section 1013 of the United States Internal Revenue Code. The like-kind exchange enables you to withhold capital gain taxes when you’ve sold an investment property and reinvest the pay from the sale within a certain frame of time in properties of like-kind or greater value.
1031 Exchange is a useful tool for managers and investors who want to defer capital gains tax. However, this form of exchange has some rules and regulations governing it.
Here are some IRS 1031 exchange rules for 2021 and beyond:
- The property must be an investment or business one.
- The properties must be like-kind, meaning they have to be similar.
- The taxpayer of the first property must be the one that buys the replacement property.
- The replacement property has to be of equal or greater value compared to the first one.
- It must adhere to the 1031 exchange timeline.
The 1031 Exchange Timeline
Normally, exchange simply means swapping property between two individuals. But it’s hard to find someone with the property you want and who’s willing to collect the property you’ve at hand.
As such, most exchanges are delayed and that’s when the 1031 Exchange timeline comes into play.
During a delayed exchange, you’ll have to get a middle man who will hold your money after you sell your property, and use it to buy your desired replacement property. This three-party exchange is regarded as a swap.
When you perform a 1031 exchange three important dates are observed:
Day 0: Selling your Existing Property
At this time, you close your existing property and start looking for a property to replace it with.
Day 45: Property Identification Period
From the day you close your relinquished property, you’ve only 45 days to get one or more replacement properties. For example, if you close your property on the 1st of May, you must find at least one replacement property by the 15th of July.
Within this period you’re expected to write to your middleman specifying the type of replacement property you’re looking for.
Also, there’s no need for your replacement property to be under contract on the last day. Instead, the middle man looking after your like-kind exchange will provide you with a form used to finalize your property identification period.
If you fail to receive your finalization form by midnight on the 45th day, then your 1031 tax exchange timeline automatically comes to an end and you’ll receive funds of your sold out property and your capital gains tax will be due and paid that same year.
Day 180: Close on Replacement Property
Within 180 days of closing the sale of your relinquished property, you must also close your replacement property.
The countdown of these 180 days begins from the day you close your relinquished property. For example, if the sale of your relinquished property closed on 1st May then you must purchase and close on a replacement property by 30th October that same year.
Also, a 1031 exchange can begin in one tax year and gets completed in the next tax year. In case this happens there’s the need for you to file a 1031 exchange timeline extension for your federal income tax return. This will enable you to use your 180 days of closing on replacement property else the timeline will expire on the day your tax return is due.
You must know that there’s no rule saying you’ve to wait for 180 days before closing on your replacement property. If you’re good with the 1031 exchange timeline, you can purchase your replacement property within the first 45 days.
FAQ About 1031 Exchange Timeline
Let’s look at some of the most commonly asked questions by investors about the 1031 exchange timeline.
What is the Reverse 1031 Exchange?
Here, there’s a reverse 1031 exchange timeline whereby you acquire replacement property before selling your relinquished property.
However, you won’t be able to use the replacement property until the 1031 exchange is completed. The replacement property will be with your Exchange Accommodation Titleholder (EAT), till the relinquished property is sold out.
A reverse 1031 exchange allows you to get your desired replacement property at the right price and time.
Are 1031 Exchanges Tax-Free?
No. 1031 exchanges aren’t tax-free; rather the tax is deferred based on the relinquished property sold out with some adjustment. However, the good news is you can roll deferred gains of your replacement property forever.
What are the Time Requirements in a 1031 Exchange?
From the time you close on your relinquished property, you have 45 days to choose a replacement property. You also have 180 days from the day you close your property to acquire a replacement property.
Does the Size of My Relinquished Property Matter?
Yes, the size of your property matters a lot in the 1031 exchange. The value of the replacement property must be equal to or more than the amount received from the sale of your relinquished property.
Can I Choose More Than One Replacement Property?
You can choose as many as three replacement properties, but this has to be clearly explained in your papers.
The deal however is, that you’ll have to choose one of these three properties as your replacement property before your 180 days run out.
If you end up choosing another property that’s not among them, then the 1031 exchange is broken and you’ll have to pay capital gains tax.
1031 exchange is beneficial to real estate investors seeing as it provides them the opportunity to defer capital gain taxes and also exchange property in a less desirable location for another in a better location. Depending on the sold property’s worth, the exchanger can also get up to three replacement properties. Nothing beats that!
However, it comes with tons of rules that can be difficult to understand. It’s therefore useful to consider seeking advice from a 1031 exchange expert to avoid making mistakes. Good luck with your exchange!