8 Weird Things You Should Know About a 1031 Exchange

The IRS collects over 3 trillion dollars in taxes every year. A lot of that money comes from taxes that Americans pay on their investments.

If you’re in real estate and investment property, chances are, you’ve paid (or are going to pay soon) capital gains taxes after a transaction. What you may not know though is that the US government has a nifty tax code that lets you defer paying taxes on some property investments until you want to.

This deferred tax trick comes via what’s called a 1031 exchange.

There are a lot of intricacies that surround 1031 exchanges and some of them are downright weird.

Below, we look at some of the weirdest things you’ll run into with a 1031 exchange so you’ll be prepared.

1. The “Like-Kind” Contingency Doesn’t Mean Much

In theory, 1031 exchanges are supposed to be for exchanging one piece of property for a similar one. This idea seems to be enforced by a contingency that states properties should be kind of alike.

The truth is though, the like-kind contingency with a 1031 exchange is very liberal. You can easily exchange a house for land or land for a commercial building without running into any trouble.

2. Personal Property Can’t Be Exchanged

A lot of people get excited by the prospect of a 1031 exchange and think that they’ll use the tax benefit for upgrading their home. Unfortunately, personal property is almost never covered under this tax code.

1031 exchanges were designed to help professional investors more easily move from one venture to the next. Because of that, if you’re trying to 1031 a place that you reside in, you likely won’t be able to qualify.

There are some cases where personal property can meet exchange requirements. We recommend looking up more info on 1031 exchanges to see if you can find helpful loopholes.

3. Exchanges are Typically Delayed

When you exchange property, it’s assumed that you’ll literally trade, on the spot, one piece of property for another. The truth is though, that rarely happens.

Most investors don’t have their eyes on another property the moment that their initial one sells. The problem is that if investors accept cash from the sale of their original property, it’ll get taxed.

To deal with this snafu, investors have an intermediary hold the proceeds from their original property rather than collecting it themselves. With sale proceeds safely in someone else’s hand, investors can take their time to find their next investment.

4. Replacement Proprieties Need to Get Designated

Even with a third party holding the proceeds from your sale, you will have to designate properties that you’re interested in investing in within 45 days. Designating properties shows the government that you’re serious about re-investing your sale profits and is the only way that you can defer your taxes.

If you don’t designate a property to reinvest in within 45 days, the cash from your original sale will be given back to you by the third party that was holding it and you’ll get taxed.

5. You Must Close on a Property Within Half a Year

While you have to flag property that you’re interested in within 45 days, you don’t actually have to buy anything until 6 months after the original sale of your property.

Therefore, in theory, you could designate a ton of properties that you’re interested in and then take your time choosing one over the course of the next half year.

That brings us to our next point…

6. You Can Designate Multiple Properties

When you designate a property within 45 days to maintain your 1031 exchange status, you can designate more than one property. That way, your options will be open as far as which property you’ll close on.

The only caveat here is that designated properties cannot be worth more than 200% of your original property’s value.

7. Any Cash You Get is Considered “A Boot”

If you 1031 a one million dollar apartment complex for one that costs half a million dollars, you’re going to come away with a positive balance (or “a boot”) of half a million dollars. That half a million dollars will get returned to you by the third party that was holding your money and every dime of it will get taxed.

Therefore, if not paying taxes is important to you, you’ll want to make sure that the property you exchange for either closely resembles or slightly exceeds the value of your original property.

8. Real Estate Gurus Scream About 1031 Exchanges

There is no place that you’ll hear more about 1031 exchanges than at a real estate meet up. That’s because 1031 exchanges allow real estate professionals to seamlessly build their wealth through upgrading properties without ever needing to share too much of their success with the government.

Because of that, we recommend attending local real estate club meetings and networking if you’re interested in learning everything you can about 1031’s. The website “Meetup” is a great place to find such meetings.

Wrapping Up Weird Things You Should Know About a 1031 Exchange

A 1031 exchange is a powerful way for professional investors to upgrade their portfolios without needing to worry about capital gains taxes. While some of the provisions in 1031 exchanges can get a little weird, we hope that our factoids above have brought some clarity to the matter.

As always, consult a tax professional before trying your hand at a 1031 exchange. Reading information online is no substitute for getting personalized and professional care from somebody that knows all about your local tax obligations.

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