Real Estate Investors and 1031 Exchange
Real Estate Investor
If someone owns any property in addition to their own home they are a real estate investor. As an investor the goal is for the property to either a) bring in cash flow and/or b) appreciate in value over time. The best goal is for the property to both bring in cash and appreciate in value.
Selling an Investment Property
For many reasons an investor may want to sell an investment property and buy something different. If the original investment property has appreciated in value substantially, there could be a LOT of capital gains tax due upon selling. One way to defer capital gains taxes is to exchange the property for a like-kind property through a 1031 exchange. Every investor should have a good tax advisor or accountant. Disclaimer: Call an accountant before deciding on a 1031 exchange.
Basics of a 1031 exchange
The rules for a 1031 exchange come from the IRS. (See above disclaimer about accountants). If the investor can find someone they can just swap properties with, that is one way to do the 1031 exchange as long as it all happens within the timeframes set out in IRS rules. Since a straight across swap is hard to arrange there are 1031 intermediaries who hold the funds from the sale of the first investment property. The intermediary then sends that money to escrow to purchase the like-kind new property.
Digging into the Basics a Little More
There are a lot of nuances in that previous paragraph! Timeframes for example. The investor has 45 days to identify a like-kind property after their initial investment property is sold. Meaning closed, not just under contract. Like-kind property doesn’t mean it has to be exactly the same for example a single-family rental home could be exchanged for a short-term rental condo. The intermediary handles all the funds. If any funds are provided to the investor, capital gains tax is very likely due on those funds.
Lot to Know, Have Experts on The Team
This is a ridiculously simplistic explanation of what a 1031 exchange is and why investors should use them. The best advice is to have experts on the team! At a minimum that would be: tax advisor/accountant, real estate agents who understand the 1031 process, the intermediary, and possibly an attorney.
This post was prompted by a recent experience with an investor client. As we looked for properties they mentioned a home they had sold as a source of funds. Never did they say an intermediary was holding the funds. After going under contract, with a little digging, the 1031 exchange surfaced. This was info needed before the contract was written. They had gotten inaccurate info about what they could do with the monies the intermediary was holding. Right now they are undecided about how best to move forward without costing themselves a lot of capital gains tax.
Call on Experts and Tell Them Everything
Bottom line, have experts at your disposal. Make sure you tell them everything so they can properly advise you. Oh that single family rental home to a short-term rental condo, that was me! Goodbye Kennewick rental, hello Maui condo! Contact me to rent it!