5 Important Facts to Know for Your First 1031 Exchange

If you are preparing to conduct your first 1031 exchange, congratulations. Not only does this mean that you’ve made a profitable investment, but it also means that you are preparing to reinvest your profits for even greater returns in the future. This is exactly what Section 1031 is designed to encourage, and while there are no guarantees, this is a proven path toward sustainable growth.

Before you move forward, there are some important facts you need to know. Keep reading to learn more from our 1031 exchange specialists.

What You Need to Know Before Your First Like-Kind Exchange

While Section 1031 is designed to encourage reinvestment with a focus on long-term growth, it also imposes strict rules and requirements. As a result, when preparing to conduct your first like-kind exchange, it is critical to make sure you know what you need to do—and, just as important, what you need to avoid doing—in order to realize the tax benefits that are available.

Here are five key facts to keep in mind:

1. You Need to Make Sure Both Properties Qualify

Under Section 1031, almost any piece of real estate can qualify as being of “like kind” with any other. However, there are exceptions, and certain types of properties are ineligible for inclusion in a like-kind exchange.

As a result, before you move forward, you need to make sure that your “relinquished” property and your “replacement” property both qualify under Section 1031. Some examples of issues that can prevent properties from qualifying include:

• Primary homes, second homes, and vacation homes generally do not qualify.
• Flip properties also generally do not qualify.
• A property in the U.S. is never considered of like kind with a property abroad.

Since the use of a property can determine whether it qualifies for like-kind exchange treatment under Section 1031, establishing that a replacement property qualifies can present particular challenges in some cases. This is just one of many areas in which our 1031 exchange specialists will be able to help.

2. Strict Rules Apply Throughout the Process

Along with the restrictions that apply to the types of properties that qualify for 1031 exchanges, various other rules apply throughout the exchange process. These include strict deadlines, among others. If you miss the deadline for identifying your replacement property or closing on one of the transactions involved in your like-kind exchange by even a single day, this can prevent you from securing indefinite deferral under Section 1031.

3. Receiving the Sale Proceeds, Even Temporarily, is Prohibited  

One of the most common types of 1031 exchanges is what is known as a delayed exchange. This involves selling your relinquished property before buying your replacement property. When conducting a delayed exchange, you cannot take possession of the sale proceeds from your relinquished property, even temporarily. Avoiding this involves working with a qualified exchange intermediary.

4. You May Receive Taxable “Boot” In the Exchange

Even if your exchange generally qualifies under Section 1031, you may still receive funds or other assets that are ineligible under Section 1031. These ineligible assets are referred to as “boot.”

Under Section 1031, boot is immediately taxable. As a result, to the extent you can, you will want to structure your exchange to avoid boot in most cases. With that said, sometimes receiving boot will be desirable (or unavoidable)—and, in these cases, investors must be careful to deal with the tax implications appropriately.

5. If Your Exchange Doesn’t Qualify, All of Your Gain Will Be Taxed Immediately

If your exchange doesn’t qualify as a like-kind exchange for any reason, all of your gain from the exchange will be taxed immediately. Generally speaking, once an exchange triggers tax liability, this cannot be undone. With this in mind, before you begin the process, you will want to make sure you have a strategy to ensure that your exchange will receive like-kind treatment under Section 1031.  

Contact the 1031 Exchange Specialists at 1031 National Services

If you are preparing to conduct your first like-kind exchange and would like to know more about what you can (and should) do to ensure that your exchange qualifies for indefinite tax deferral under Section 1031, we invite you to get in touch. Our 1031 exchange specialists have extensive experience helping investors navigate the process, and we are able to serve as a qualified exchange intermediary as well. To get started with a free phone consultation, give us a call at 888-872-1031 or contact us online today.