Attention Real Estate Investors!! Is it possible that you are considering selling your investment property but want to actually stay in the real estate game and purchase another property, perhaps even a vacation home? Of course you know the tax implications that follow…there are not just one tax but there are three taxes to pay if you don’t do a Section 1031 Exchange…The Capital Gains tax is 15% and will be increased to 20% next year, the State of Colorado is another 5%, and the Recapture of Depreciation is another tax that needs to be calculated. This could be a potential 30% blended rate of taxes! A 1031 Exchange is the deferral of capital gains taxes that could save you thousands of dollars. I always recommend you speak with your CPA or tax advisor and/or your attorney before determining if a 1031 Exchange is the right scenario for your real estate transaction.
I also want to define for you the term “Like-Kind Exchange” before I go on to share with you the 6 Rules of 1031 Exchanges. “Like-Kind” is somewhat of a misnomer. You do not have to reinvest in commercial real estate if that is what you are selling. The same applies with residential property or raw land for instance. The term “Like-Kind” really just refers to real estate in general so feel free to exchange the kiddie condo for the commercial strip mall or even the vacant lots for a single family rental home.
The “6 Rules of a 1031 Exchange” is a simple way to determine if the sale of your investment real estate qualifies and is in fact exchangeable.
Rule #1 –What you sell and What you buy or Exchange into must be “Held for Investment” or “Used for Business” for usually 1 year and 1 day. The Internal Revenue Service tends to views this length of time as a long term capital investment vs. a short term capital investment which is why a Fix & Flip generally does not qualify.
Rule #2 – 45 Day ID Rule – The 1031 Exchange actually starts on the day of closing for the sale of the “Relinquished Property”. You have exactly 45 calendar days to identify in writing up to 3 potential “Replacement Properties”.
Rule #3 – 180 Day Rule – You have exactly 180 calendar days from the date that you closed on the “Relinquished Property”, to close on and complete the purchase of your new “Replacement Property”. This time line runs in conjunction with the 45 Day timeline for identification.
Rule #4 – QI or “Qualified Intermediary” Requirement- The IRS mandates that you use a QI or Accommodator, and it cannot be your personal attorney or your accountant. The IRS also does not allow that you as the seller, touch the money in any way during the exchange.
Rule #5 – Title Requirement – You must not change how you hold title prior to the exchange or after the exchange for at least 1 year and 1 day or you may invalidate it. This applies to both the OLD property that you are selling and the NEW property that you are buying. There are some exceptions, such as disregarded entities.
Rule #6 – Reinvestment Requirements or Equal-or-Up Rule-To have ZERO tax implications come tax time you must buy equal or greater, AND you must reinvest all the cash. Keep in mind also that in order to accomplish this you may even buy more than one property. If you do buy down then you will have to pay the tax on the difference and only that portion is taxable. The commonly used term for that is “boot”. You could also elect to keep some of the cash and that portion would be taxable as well.
When determining which Qualified Intermediary or 1031 Exchange Company to use please make sure that the funds are never comingled and that the company that you choose can provide you the Safety and Security of your Exchange funds entirely.
Assistant Vice President
Investment Property Exchange Services, Inc.
Cell - 303-242-6572
Office - 877-775-1031