How do 1031 Exchanges work?

How do 1031 Exchanges work when selling property? Most people and accountants don’t understand 1031 exchanges. If you are planning to complete a 1031 exchange, I’d recommend reading book called “Exchanging Up” by Gary Gorman. You should avoid paying Capital Gains taxes when you sell income property. What you need to do is exchange “like kind” income property and defer your Capital Gains to the next property, and this is called a 1031 exchange.

How to avoid paying capital gains when selling property? You should always be very careful to follow the 1031 exchange rules exactly. Someday, when you’ll get tired of owning and managing your portfolio of income property, you can 1031 exchange your income property for REIT’s (Real Estate Investment Trust) and defer the Cap Gains until you die. You can find LOTS of good information regarding 1031 exchanges on the internet, for instance here and here.

1031 Exchange Rules

The basic rules to a 1031 exchange are as follows:

– You have to exchange an income producing property for a “like kind” property.  You can sell one house and replace it with, for example, three houses in another state. You also can sell an apartment building and replace it with a house. You can sell a house and exchange it with a REIT. I think you could even exchange your property for a boat or a RV, as long as it’s covered under the governments definition of “like kind” (however I wouldn’t recommend going this way).

– You have to close on the replacement property(ies) within six months, or by April 15, after closing on the sold property.  This makes it hard to replace the sold house with new home builds, because a new home build can take 12 months to build!

– You have to replace the property that you’ve sold with the property or properties that costs as much or even more.

– You have to identify the replacement property or properties within 45 days of closing on the sold property.

– The 1031 exchange company must appear on the HUD closing statement as SELLER.

You may not touch any of the proceeds from the sold property. All of the proceeds are wired to the exchange company (or the “accommodator”), and they forward the money along to your next transaction. Later on (after the 1031 exchange is complete), you can take money out of your income property. You can refinance it and take out cash. Mind that if you don’t have an excellent Accountant who is familiar and comfortable working with 1031 exchanges, it’s better to find yourself a new one. Remember that you have to play by the rules, if you want to take advantage of the 1031 exchange opportunity.

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