The 1031 Exchange is a versatile tool that helps real estate investors defer their capital gains tax. It also functions as a means for dumping under-performing assets (among other benefits).
So, it’s no surprise that you’re considering this convenient option. However, while in this exploratory phase, you need to make sure you’ll be qualified and prepare to initiate one when the time is right.
To this end, we compiled this list of questions you should be asking.
- Do I currently own real estate property?
The most commonly exchanged asset is real estate property. Some caveats are that properties can’t be an investor’s primary residence; a personal residence would not qualify for a 1031 Exchange. Property must be one that they currently own. Any property you’re exchanging — and exchanging for — must be for investment or business use. So, the first questions to ask are: 1. Do I currently own property? 2. Does that property meet this description?
- Is there a capital gains or recaptured depreciation tax?
The main reason for initiating a 1031 Exchange is to defer the taxes you will pay. As such, the next question you should ask is if there will be a capital gains or recaptured depreciation tax levied when selling your existing property. If not, the 1031 option makes little sense.
- Am I aware of other types of property that qualify for exchange?
Significantly, your ability to perform a 1031 Exchange isn’t limited to owning real estate property. In other words, many other types of holdings — again, so long as they are owned for “investment or business use” — qualify for an exchange. These include: land, various types of commercial property, vacation homes, ranch / farm land, and even aircraft.
- Am I aware of these two critical requirements?
As investors get closer to initiating a 1031 Exchange, there are two critical requirements they need to know. The first is the 180-day timeframe, which is when you must complete your 1031 Exchange transaction (including the conveyance or receipt of title to all of like-kind replacement properties) no later than:
(1) midnight of the 180th calendar day following the close of the relinquished property sale transaction – or –
(2) the due date of your Federal income tax return for the tax year in which the relinquished property was sold, including any extensions of time to file.
Furthermore, the property you are exchanging for must be of equal or greater value (debt and equity) than the property you’re selling.
- Do I know other reasons for 1031 Exchange?
Other reasons for performing a 1031 Exchange include: resetting an investor’s depreciation schedule, increasing their cash flow and enabling portfolio diversification.