NEW YORK, March 1, 2022 (Newswire.com) - A 1031 like-kind exchange is a way investors and property owners postpone capital gains taxes on the sale of a property by exchanging it for another similar, or like-kind, property. While this exchange may sound simple in concept, meeting the requirements of like-kind exchange rules can be a challenge. That's why it's important for investors to prepare accordingly and get the right team in their corner to support the transaction from start to finish.
Here are four ways to prepare for an upcoming like-kind exchange.
1. Calculate potential capital gains savings
Perhaps the biggest allure of a like-kind exchange is the ability to delay paying capital gains tax on a property. So, as an investor preps for a 1031 exchange, they should assess how much deferred capital gains will save. Understanding savings may enable investors to plan for property renovations or find a suitable exchange property for a higher amount than originally planned.
Some online calculators can estimate the savings from a 1031, but investors should consider working with a real estate attorney or accountant too for the most accurate numbers.
2. Create a timeline
The tax deferral of a like-kind exchange is a big draw, but property owners need to meet tight deadlines to make it work. Investors have 180 days from the sale of the first, or relinquished, property to complete the purchase of the replacement property.
But the more critical and fast-approaching deadline is 45 days following the completed sale of the relinquished property. By 45 calendar days after the sale, investors must identify up to three eligible replacement properties that fit the like-kind exchange parameters. Sticking to this timeline is mandatory; otherwise, investors could forfeit the tax protection of the exchange.
3. Find an intermediary to execute the transaction
Like-kind exchanges require a qualified intermediary to perform the transaction because the IRS has specific rules for executing a 1031. As a result, even the slightest misstep or delay in paperwork could result in a hefty tax bill the investor didn't anticipate.
Investors should identify this intermediary before listing the initial property to ensure a smooth exchange. For those investors who are doing a 1031 for the first time, a realtor is an excellent resource to recommend an appropriately qualified intermediary with a track record of successful exchanges.
4. Identify up to three new potential properties
Investors must identify up to three potential replacement properties within 45 days of the sale of the first property. The list can change until day 45, then it's set in stone, and the property purchased must be on the list.
Investors can prepare to create this list by looking at replacement properties in advance to determine the location of the replacement, how long properties are staying on the market, and the true market prices for that area. Looking at replacement properties ahead of listing the first property for sale is wise and can save a lot of stress around being unable to find a property when it's crunch time.
The Bottom Line
Deferring capital gains taxes using a 1031 exchange is a smart move for real estate investors looking to trade up into higher-value properties. Investors can prepare for the exchange by calculating savings, creating a timeline, identifying the right qualified intermediary, and searching for potential replacement properties in advance. Doing so can help ensure a smooth exchange and guarantee an optimal financial outcome for the investor.
Source: National Association of Realtors