So, what is the real deal with 1031 exchange properties? Is it worth investing in? 1031 exchange properties (also known as starker or like-kind exchange) refer to the swap of one investment asset for another. Though swaps are in most of the cases taxable, 1031 exchange is taxed slightly or not at all.
Even you are allowed to alter the type of investment without recognizing a capital gain or cashing out. So, your investment grows without being tax deferred. Moreover, there is no cap on doing 1031 exchange for many times. There is an opportunity to roll over the gain from one investment to another. And you can reap profit from each swap, without having to pay tax until you decide to cash out and sell. Thus you are paying tax only once, and that is also just 15%!
1031 exchange properties are not for personal use.
The provision applies only to business and investment properties, so there is no way to swap your residence for another house. Nevertheless, a loophole in the clause accommodates swapping vacation properties; but the application is quite rare.
You have to designate replacement property.
In case of a delayed exchange, you have to follow two limiting rules. The first one is the designation of replacement property. Once a sale is made, the cash goes to the intermediary. If you receive the cash instead, the 1031 will go to waste. In addition to that, you have to provide the intermediary with a designated replacement in writing for the property. You also need to specify the property you wish to acquire.
You have to close within six months.
The second timing rule dictates you have to close on the new property within 3 months of selling the old one. The both time periods are concurrent. So you start as soon as the sale closes. For example, if you designate replacement property after 50 days, then you have exactly 130 days left to close.
“Like-kind” is broad.
The phrase “like-kind” is far away from what you think it is. For a strip mall, raw land, or ranch, you can exchange an apartment building. It allows you to exchange one business for another as well. However, it is not that easy as it seems, as there are many ‘buts’.
If you receive cash, it is taxed.
After the intermediary acquires the replacement property, you may be left with cash. If this is the case, the intermediary is bound to compensate it at the end of the three month time frame. The cash is known as “boot” and is subject to taxing as partial sales proceeds from the sale, usually as a capital gain.