Like-Kind Property Exchange
A 1031 exchange is a unique opportunity for a property or business owner to leverage their property’s full purchasing power. When you transfer property via a sale or some other transaction, the sale’s income is subject to several taxes. The extent of these taxes vary by state, but in no location within the US will a property owner leverage the full purchasing power of their property.
The IRC 1031 is a method of transferring property so that the proceeds of the transfer can be used to acquire another property of like-kind.
Like-Kind property transfers refer to the nature of the investment. Any particular type of investment property may be exchanged for another investment property, i.e., like-kind investment property.
There is a lot of flexibility in the types of property that like-kind investment cover. Offices may be exchanged for apartments, or undeveloped land may be exchanged for developed areas. Because of this type of flexibility, like-kind property transfer is a beneficial method of using the 1031 for many DeferTax’s clients. At DeferTax, our aim remains to offer the best options to ensure our clients can benefit. The Like-Kind Exchange is one of those options our clients can explore.
What is Classified as a 1031 Exchange Property?
The only significant stipulation for exchange properties is that the real estate must be a business or investment property. Principal residences are not covered under this definition, and so you can’t perform an exchange using your personal residence as the transferrable property.
Changes to the 1031 have limited the assets that can be transferred under the 1031, but for now, the definition of like-kind property transfer remains the most versatile.
Additional properties that cannot be traded via a 1031 exchange include speculative or flipped properties, stock in trade, or developed lots. Second homes may or may not fall under the non-exchangeable property list depending on the local state tax laws and the property’s usage.
Types of Like-Kind Exchanges
Like-Kind exchanges, just like other 1031 exchanges, can take place in several different fashions. Simultaneous exchanges occur on the same day but require a lot of planning since both parties need to be available to sign documents simultaneously. A more common method for 1031 like-kind exchanges is the deferred exchange.
The 1031 stipulates that the deferred exchange must take place within 180 days of the initial acquisition. Reverse exchanges are also possible, where the exchangor receives a property that he or she finances before relinquishing another property of like-kind.
It’s a common misconception that like-kind properties mean properties of the same size or usage. This misconception has plagued many DeferTax’s clients, and they are pleasantly surprised to know that the use or the size of the property has no bearing on its qualification as like-kind. Any asset that qualifies as a business or investment property can be traded for another business or investment property.
How often Can you Perform a Like-Kind Property Transfer?
While you can only use a property once in a like-kind transfer, there’s no stipulation on how many of those transfers you can perform per year. Once you have property, you can keep using them as like-kind transfers to utilize the full purchasing power of their proceeds. It’s a unique way to build deferred wealth using real estate by avoiding the taxes associated with selling assets.
1031 exchanges aren’t something that you can perform on your own, unfortunately. The IRS requires that a third party be present as an intermediary or facilitator. DeferTax serves as the qualified intermediary (QI) for all our clients’ 1031 exchanges. Our experience in the field makes us an excellent choice for clients who are only just getting into the real estate market or those who know the ropes and need a skilled QI to help them meet their goals.
Because 1031 exchanges can be complicated, we enjoy informing our clientele about their options when it comes to like-kind property transfer. That way, they can make the most informed decision regarding their available options.
For like-kind properties, there are unique situations where you may want to perform an exchange, but the property you’re getting may not be as developed as the relinquished property. Improvement exchanges allow you to utilize the full purchasing power of your property’s value uniquely.
Several situations exist where you may exchange property for another that hasn’t been improved yet. The exchangor is very likely to get positive interest from buyers in an exchange like this, but such an exchange’s long-term benefits can be quite lucrative.
Improvement exchanges require the exchangor to close the deal AND finish improvements before the end of the 1031-stipulated 180-day window for closing the deal. If the upgrades are unfinished, the exchangor could get hit with taxes for the difference in value between the properties. Improvement exchanges also may involve additional cash or assets known as “the boot” which may also be subject to taxes, even though the property exchange is not.
Foreign Properties Are Not Allowed
While the kind of property is flexible, the location of the property is not. Like-kind property carries with it the caveat that the property must be within the United States. Before 1989, exchangers had the option of switching out IS-based territory for properties they held outside of the country’s borders. Revamping of the 1031 has made it so that like-kind properties now only refers to properties situated within the United States.
Multiple Property Transfers Are Okay
Several of our clients were unaware that the 1031 exchange isn’t limited to a single property. Instead, exchangers can switch one property for several other properties, if they so please. The property values need to be similar, but no rule states that it must be a one-for-one transfer. Clients have managed to get creative in their acquisition of new properties to make up the difference.
1031 exchanges can be complicated to navigate, but you shouldn’t have to make things more complicated than they already are. Now that you know what like-kind properties are and how they can be used, you’re in a unique position to improve your real estate investment. Contact DeferTax today, and let’s help you make the most out of your properties.