1031 Exchange Rules to Follow for A Successful Transaction

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A 1031 Exchange is a real estate investing tool that allows you to defer paying capital gains tax. This is an excellent opportunity to take advantage of if you have an investment property you’re looking to sell to purchase another similar investment property afterward. There are, of course, things to be aware of and 1031 exchange rules you must strictly follow.

5 Rules and Requirements to Familiarize Yourself With

Keep in mind that these 1031 exchange rules may vary to different degrees depending on state regulations, whether the property is commercial or residential, and the sale timeline.

1.     Like-Kind Properties

As defined under the Internal Revenue Code, a like-kind property is held for investment, trade, or business purposes. Therefore, both properties involved in the exchange of real property must be for either investment or business purposes only. Primary or secondary homes do not qualify. Additionally, both properties also need to be located in the United States. A few like-kind property examples:

  • A restaurant for a movie theater
  • An apartment building for a similar or larger apartment building
  • Vacant lot for a shopping center
  • Storage facility for an office building

2.     45–Day Time Limit

This rule refers to the amount of time the seller has to find an exchange property to purchase that qualifies. The seller has 45 days from the actual sale date to identify the potential replacement property. This time is referred to as the “identification period”. Once the seller of the first property identifies a property, it must be written in a document, signed, and handed to the seller or the qualified intermediary.

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3.     180–Day Rule

The countdown begins the day you sell your property. You then have 180 days to identify a property (the 45–day rule starts on the same day) and complete the purchase, or else it will not qualify. 1031 exchange rules are stringent, and the timelines are non-negotiable. As a result, the seller looking to purchase a property will often identify a few, if possible, to help their chances of one working out as a 1031 exchange.

4.     The Three Property Rule

As stated above, you can identify a few properties to help with your odds of getting one closed within 180 days; however, you are only allowed to identify up to three properties. Therefore, the buyer may only choose from one of these options within the 180-day window to successfully complete the exchange.

5.     The 200% Rule

This rule plays off of the Three Property Rule in that if the buyer wants to identify more than three properties, they can, but under one condition. The rule is that as long as the total fair market value of what they identify does not exceed more than 200% of the fair market value of the property sold. Using this rule is an additional way to help ensure your chances of finding a property to close on in time.

The Complexities of 1031 Exchange Rules Require Guidance

With a 1031 Exchange allowing you to defer your capital gains tax, you have more capital, increasing your buying power and potential. If you qualify for this great opportunity, you should consider taking advantage of it. However, with its complicated and particular structure, it is advised that you seek advice from your financial advisor. There is too much on the line to be unsure of the procedures and how to fulfill them correctly.

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Types of Ownership Structures in a 1031 Exchange Explained
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