1031 Exchange In A Nutshell


For property investors, it's important to understand the language of the capital gains tax law as well as the 1031 exchange provision that helps you defer your capital gains tax on an investment property sale. If you're thinking about selling a property and have plans to ultimately purchase another property to replace it, you should consider a 1031 exchange instead of just completing the sale, taking the proceeds, and purchasing another property when you're ready. Here's a look at how the 1031 exchange process works and how it can help you.

It Starts With A Sale

A 1031 exchange starts with the sale of the property that you currently hold. You'll need to sell this property before buying another property to avoid the capital gains tax. If you are selling and buying at the same time, you'll need to identify an intermediary for your 1031 exchange at this stage. You shouldn't close on the sale without an identified intermediary to receive the cash on your behalf. 

When your property sale closes, the cash will be transferred to the intermediary. If the money is given directly to you, you immediately become liable for the capital gains tax because that money was in your possession. That's why it's important that your intermediary be part of the sale and closing process to receive those funds on your behalf.

The Intermediary Holds The Funds

There's a good chance that you've been looking for a similar property to reinvest in, but you probably haven't found one by the time you close on your existing one. If so, that's okay. Your intermediary will hold your funds for you after the sale to give you 45 days to find some property options. Within 45 days of the sale, you have to provide the intermediary with written interest on up to three properties. Choose them carefully, because you'll have to close on one of those properties within six months of closing on your property sale.

The Funds Are Transferred Directly To The Seller

When you close on the new property, your intermediary will transfer the funds directly to the seller. This ensures that the IRS rules are followed, which require that the funds for the property sale do not reach your possession. If there are any funds left over after the purchase of the property, your intermediary will issue those funds to you once the closing is complete. You will, however, be charged capital gains tax on those remaining funds.

For more information about 1031 exchange services, contact a local agent who can advise you.


6 November 2020

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