4 Essential 1031 Exchange Strategies To Use in a Seller’s Market (2024)

FAQs

What are the four different types of 1031 exchange structures? ›

How Does A 1031 Exchange Work? As a seller, you can postpone capital gains taxes by selling a property and putting the proceeds toward a like-kind property, or property similar in nature and value. If you don't receive any proceeds from the sale, there's no income to tax.

A 1031 exchange is a tax strategy that allows investors to sell an investment property in exchange for another property, then defer capital gains from the first property's sale. This strategy is advantageous for investors who wish to purchase more real estate rather than cash out.

A 1031 Exchange allows Landlords to sell their investment property without the tax liability and better position themselves to achieve financial and lifestyle objectives on the reinvestment.

The term boot refers to non-like-kind property received in an exchange. Usually, boot is in the form of cash, an installment note, debt relief or personal property and is valued to be the “fair market value” of the non-like-kind property received.

If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable.

A 1031 exchange must be completed within a 180-day period. This starts from the date of the sale of the relinquished property. If the exchange isn't completed within that time frame, it's considered invalid.

The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary.

As a general rule, an investor can rescind their sale transaction as long as it occurs in the same tax period in which the property is sold. Doing so would allow them to re-do the sale and complete a 1031 Exchange the second time around.

Delayed Exchange

Delayed exchanges are the most common form of 1031 exchanges. Exchangers have 45 days to identify a like-kind replacement property and must close on the property within 180 days.

How do you maximize a 1031 exchange? ›

Commercial property including rental properties, condominiums, shopping centers, strip malls, timberland, gas and water interests, and land represent real property eligible for a 1031 exchange. One of the popular examples of 1031 Exchange replacement properties include Delaware Statutory Trusts or DST properties.

The taxpayer and the related party must hold the properties that each received as part of the 1031 Exchange transaction for a minimum of two (2) years. The two (2) year holding period starts running on the date of the transfer or conveyance of the last property involved in the 1031 Exchange related party transaction.

A 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows you to avoid paying capital gains taxes when you sell an investment property and reinvest the proceeds from the sale within certain time limits in a property or properties of like kind and equal or greater value.

One of the most important is that real estate investors must reinvest all of their sales proceeds into the new property. If they don't, the portion not invested is known as “boot” and that part of the gain is taxable.

There are two types of the boot: Cold Boot/Hard Boot. Warm Boot/Soft Boot.

95% Rule.

The 95% rule says that a taxpayer can identify more than three properties with a total value that is more than 200% of the value of the relinquished property, but only if the taxpayer acquires at least 95% of the value of the properties that he identifies.

Thanks to a recent Disaster Notice issued by the IRS, affected taxpayers like you now have until October 16, 2023 to BOTH Identify and Close on a new “replacement” property for a 1031-Exchange. This is a once in a lifetime chance to take advantage of the government's offer as a real estate investor.

What is the average return on a 1031 exchange? ›

DST Returns On Investment - What Could You Expect? Typical DST Returns on a 1031 exchange investment could yield between 5%- 8% of monthly distributions based on your fractional interest.

Under IRC §1031, the following properties do not qualify for tax-deferred exchange treatment: Stock in trade or other property held primarily for sale (i.e. property held by a developer, “flipper” or other dealer) Securities or other evidences of indebtedness or interest. Stocks, bonds, or notes.

Yes. But the family member cannot sell the property for two years; otherwise their transaction will trigger the tax you have deferred. The IRS is looking for what is called related party transactions on Form 8824 used to file the 1031 exchange with your yearly Form 1040.

As such, when it comes to real estate flipping and 1031 exchanges, these two activities are incompatible. They have different investment purposes, adhere to different processes, and generally follow different hold periods.

This 180 day period is the maximum time that the funds can be retained in the escrow account that the qualified intermediary has established for the exchange.

There is no restriction on the number of times you can participate in a 1031 exchange. As long as you meet all the requirements and have an experienced intermediary by your side, you can use this tool as often as possible to minimize your capital gains taxes.

Your personal use of the property, including occupancy, must not exceed either 14 days or 10% of the total number of days you rented out the property within 12 months. This exchange only applies to single-owner properties. Once the 24 months conclude, you can move into the property and declare it a primary residence.

SELLING MULTIPLE PROPERTIES IN AN SECTION 1031

When performing a Section 1031 tax-deferred exchange, an exchanger may sell multiple relinquished properties in a single exchange, exchanging several properties into one (or multiple) replacement properties.

The properties being exchanged must be considered like-kind in the eyes of the IRS for capital gains taxes to be deferred. If used correctly, there is no limit on how frequently you can do 1031 exchanges.

In a standard 1031 exchange, you need to reinvest 100% of the proceeds from the sale of your relinquished property to defer all capital gains taxes. In a partial 1031 exchange, you can decide to keep a portion of the proceeds. This boot amount is taxable, while the money you reinvest is not.

What are the risks of 1031 exchange? ›

Some of the risks of 1031 exchange DST properties may include the fact that there are no guarantees for monthly distribution amounts, no guarantees for projected appreciation, illiquidity, loss of day-to-day management control, interest rate risk and potential loss of entire principal amount invested.

If you do not identify or acquire the replacement property within the 45 days, you are not able to complete a valid exchange. In addition to making sure you identify replacement property within 45 days, you must identify it unambiguously. That generally means using a legal description or street address.

Most investors swap two properties via a 1031 exchange – an old property is sold and replacement property is purchased. However, you can identify up to three properties in a 1031 exchange. Once you identify the three properties you intend to sell, you can identify up to three replacement properties.

1031 Exchange requirements must be applied in the Improvement Exchange. This requirement means that all improvements must be constructed within the 180-day time period.

DSTs differ from Tenancy in Commons (TICs), another 1031 Exchange fractional ownership strategy, in that each investor does not own a fractional, undivided interest in a property as a co-owner. Therefore, DST investors are not required to share the associated costs of ownership, or be considered “tenants in common.”

There are four main types of like-kind exchanges that real estate investors can choose to execute. The types of 1031 exchanges are simultaneous exchange, delayed exchange, reverse exchange, and construction or improvement exchange.

The property that you obtain must be a “like-kind property” in order for the transaction to be considered a 1031 exchange. However, this is a broad term, which means that the property you obtain doesn't need to be exactly the same as the one that you relinquished.

For those looking for diversification and more control over liquidity, a 721 UPREIT may be preferable. On the other hand, while a 1031 exchange offers more limited options for diversification, it allows investors to continue reallocating their real estate portfolio without incurring immediate tax liability.