Three Types of 1031 Exchanges
When talking about investments, the mention of 1031 Exchange properties is becoming a more and more popular route for many people. In a crowd of realtors, bankers and financial advisors, this type of investment isn’t new at all, but it has become much more attractive and accessible to a wider band of regular investors.
A 1031 exchange may sound complicated and intimidating, but in simple terms it is the simple reinvesting of any proceeds that are made from the sale of a business or property back into another similar investment. This allows you to avoid paying capital gains taxes on your purchase.
This tax break is a welcome savings for many folks, even if they aren’t in the business of real estate investment. Although the definition may sound simple enough, there are plenty of rules and tax regulations that must be met for the investment to be valid. There are three types of 1031 exchanges that can be used — and rules of validity that must be met — that you need to know about before taking any financial action.
This is the most common type of exchange that is used. Once you sell your current business or property, you have 45 days to identify in writing a new property or business that you are interested in purchasing.
The rules that must be met to make it a valid exchange are:
- You can list up to three potential properties, regardless of value.
- Identified properties cannot exceed over 200% of the value of the sold property.
- You must receive at least 95% of the replacement property prior to the 45 day deadline.
- You must use a qualified intermediary to handle all of the funds.
- Both properties’ sales must be closed within 180 days.
This type of exchange can be done in as little as one day. You may use a qualified intermediary for the handling of the funds, but it is not necessary as per the rules. In this exchange, the property being relinquished and the replacement property are sold and purchased at the same time.
This is the least used method of 1031 exchanges, as it entails more risk to the investor. In this method, the replacement property is purchased prior to the relinquished property sale.
1031 Exchanges In General
While there are different methods to proceed with an exchange, there are certain things that must be met regardless of the route you take. The replacement properties’ value must be equal to or exceed the value of the relinquished property. There may be more than one property purchased as long as the combined values meet this requirement. Also, the full amount of the equity from the sale must be invested. Any cash amounts that are taken out of the equity will be taxed.