The 1031 Exchange — How It Saves You Taxes, and How to Do It Correctly
Whether you’re a seasoned real estate investor or new to the game, you may have heard about the 1031 Exchange – a powerful tax-deferral strategy that allows you to defer capital gains taxes on investment property sales. One of the biggest problems we solve at MartelTurnkey is to help our investor clients execute successful 1031 exchanges.
Let’s take a look at what a 1031 exchange is, how it works, its benefits and drawbacks, and how we help investors take advantage of this valuable tool.
What is a 1031 Exchange?
A 1031 exchange, also known as a like-kind exchange or a Starker exchange, is a provision in the U.S. tax code (Section 1031) that allows real estate investors to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a new, qualifying property. The primary goal of a 1031 exchange is to enable investors to reinvest their profits and defer taxes, allowing them to grow their investment portfolios more efficiently.
How Does a 1031 Exchange Work?
Sell the Relinquished Property. The investor sells the original investment property, referred to as the “relinquished property.”
Identify Replacement Property. Within 45 days of the sale, the investor must identify up to three potential replacement properties. These properties must be of like-kind, meaning they must be of the same nature or character, regardless of their quality or grade.
Purchase Replacement Property. Within 180 days of the sale of the relinquished property, the investor must complete the purchase of the replacement property.
Use a Qualified Intermediary. To ensure compliance with IRS rules, a qualified intermediary (QI) must hold the proceeds from the sale of the relinquished property during the exchange process. The QI will transfer the funds to the seller of the replacement property when the transaction is finalized.
Benefits of 1031 Exchange
Tax Deferral. The primary benefit of a 1031 exchange is the ability to defer capital gains taxes, which can be as high as 20% for federal taxes, plus any applicable state taxes. This allows investors to use the full amount of their profits to acquire new properties, increasing their overall investment potential.
Portfolio Growth. By deferring taxes, investors can more rapidly grow their real estate portfolios, taking advantage of the power of compounding and leveraging their investments for greater returns.
Flexibility. A 1031 exchange allows investors to adjust their investment strategy, diversify their portfolio, or change property types without incurring immediate tax liability.
Drawbacks of a 1031 Exchange
Strict Deadlines. The 45-day identification window and the 180-day purchase deadline are inflexible, and failure to meet these deadlines may result in the disqualification of the exchange, resulting in immediate tax liability.
Complexity. The process of completing a 1031 exchange can be complicated, and investors must follow specific rules and regulations to ensure compliance with the IRS.
Dependence on a Qualified Intermediary. The use of a QI is crucial for a successful 1031 exchange, but finding a trustworthy and experienced QI is essential, as they will hold the proceeds from the sale during the exchange process.
How MartelTurnkey Can Help With Your 1031 Exchange
MartelTurnkey can help you execute a successful 1031 exchange in a number of ways. Here’s how:
Property Identification. No need to sweat that 45-day property identification deadline. MartelTurnkey always has a selection of cash-flowing turnkey rentals ready to go. Click here to browse our current offerings.
Meet The Deadlines. In addition to sourcing properties, we also pair our investors with professionals who know how to get the job done quickly. You don’t have to worry about that 180-day closing deadline either — our teams can get it done.
Get It Done Right. In addition to pairing you with professionals who can meet the closing deadline, we can also refer you to reputable QIs who will make sure that the complex paperwork is done correctly.
Considering a 1031 exchange? Or considering acquiring your first investment property so you can take advantage of a 1031 exchange in the future? Reach out to us today!