Buying real estate with a 1031 exchange
South Walton Beach is a great place to use a 1031 exchange
Some of the most beautiful ocean views are had along the coastline that runs parallel to 30A in Northwest Florida. If you are looking to invest in real estate, why not consider Santa Rosa Beach, Watercolor, Rosemary Beach, or Seaside(the community-made famous in Jim Carrey’s movie The Truman Show.) The beaches along 30A are some of the most popular vacation spots in the country. Why not use a 1031 tax-deferred exchange to trade your current condo for a luxury rental home?
“That sounds like a good idea”, you might say, “but I’ve heard 1031 exchanges are really complicated.” Actually, they are not all that complicated, but they do require adherence to the law. You will need a good realtor and a qualified intermediary (QI) on your team.
What is a 1031 property exchange?
“So, what exactly is a 1031 exchange?” The term 1031 exchange comes from the section of the IRS tax code that deals with like-kind exchanges. A 1031 exchange can also be known as a like-kind exchange, as referred to in the tax code, or a Starker exchange, based on the name of the lawsuit that first identified the exchanges as legal. A like-kind exchange means that you are exchanging business or investment property for business or investment property. You can no longer exchange valuables like art or jewelry. The properties you are exchanging do not have to be the same types of property, but they do have to be properties used for investment or commercial purposes.
You cannot apply the 1031 exchange to personal property, like your primary residence. You can, however, exchange a large real estate holding like a farm, apartment complex, or luxury rental home for several smaller properties as long as the combined cost of the new properties is the same or greater as the cost of your original property. Other details of a like-kind exchange are listed below.
1031 exchange rules
You have 45 days after the sale of one property to identify the next property you will be purchasing. You may present 3 different properties, as long as you end up closing on one of them. In certain circumstances, you may be able to present more properties if they pass the valuation tests.
You must close on the next property within 180 days of the sale of the first property or your next tax return’s due date, whichever comes first. No extensions will be granted.
It is recommended to use a qualified intermediary to handle the transactions. (If you choose to work with a 1031 Exchange Company, be sure they are insured to protect your money from disappearing in escrow.)
Property can not be sold to a related party for two years. A related party is defined as spouses, siblings, parents, children, or corporation or partnership where you own more than 50%.
Why do a 1031 exchange?
So why do people engage in 1031 property exchanges? According to Realty Mogul, there are a number of reasons as to why people use a 1031 Property Exchange. The number one reason is to defer taxes. After all, who isn’t looking for a way to reduce their tax bill? People also use the 1031 in estate planning so their heirs don’t get hit with a huge tax bill. Sometimes real estate investors want to exchange a property that has maxed out its depreciation for a property with additional depreciation. Perhaps the property isn’t producing as much revenue or appreciating as quickly as the owner would like.
Real estate is all about location. With an eye toward the future, an investor might exchange a property in an area that is losing property value for a property in an area where property values are increasing. If investors move a distance away from their investment properties, it makes sense for them to use a 1031 Exchange to purchase new properties closer to home. Sometimes the reason for the exchange is simply that the investor finds a property he/she likes better.
What can a 1031 exchange be used for?
1031 property exchanges are only valid for investment and commercial properties. An investor may be looking to diversify his/her investments, for example, selling a strip mall and buying an apartment building, a rental condo, and a small business location. Other real estate investors want to consolidate their investments so they trade several small properties for one large property. A 1031 property exchange is also used to maximize the multiplication and leverage potential for an investor. And some folks are just ready to trade co-ownership for single ownership. Whatever the reason, many real estate investors are finding 1031 exchanges help them maximize their return on investment.
Using a like-kind exchange can help investors grow their investments tax-deferred for as long as they like. Let’s say you decide to invest in a rental condo when you are fresh out of college. If you continue to exchange up – one condo turns into two turns into a single-family home, etc. – by the time you reach retirement, you will have built up a revenue stream that can help support you in retirement. If you hire others to manage your properties, you’ll have that income without having to do much work.
There is no limit to the number of exchanges you can make. If you decide to sell your investment properties at some point, you will be taxed at the long-term capital gain rate, which is about 15%-20%. If your investment property becomes part of your estate, it is adjusted to its current value upon your demise, so your investors will not have to pay the long-term capital gains tax. However, if your off-spring are following in your shoes as property investors, they can keep delaying the capital gains taxes as long as they keep selling and purchasing property.
Can you use a 1031 exchange property for personal use?
What if you want to use a like-kind exchange for your beach house that you rent out? After all, we are talking about the Emerald Coast. You’ll want to enjoy it as well. You can make this work in your favor, but you will need to be very careful about following the rules.
You must rent the home for at least 6 months out of the year in an official capacity, meaning you are charging a fair rental fee and you have renters.
If you wish to buy new investment properties, you must rent them at fair market value for at least 14 days in the following 2 – 12 month periods.
Your personal use of the property cannot exceed 14 days or 10% of fair rental days, whichever is less.
You must wait 5 years before selling the property as a personal residence in order to receive the tax credit for personal residence sales.
Wrapping it up
Real estate is known to be a good investment because people are always going to need a place to live. Northwest Florida is a great place to invest because the beach isn’t going anywhere, and it’s a popular vacation destination. Contact the Destin Property Expert, who also offers expert service for all the communities along 30A, to begin your journey as a real estate investor today.
Additional real estate resources
Paul Sian takes another look at 1031 exchanges for real estate.
Petra Noris gives a good insight into whether it’s better to use a listing agent to buy your home or a buyers agent.
Kevin Vitale warns how to avoid buyer mistakes that could be costly.
Karen Highland explains how to use a 1031 exchange as a good investor tool.