The 1031 Exchange Timeframe: A Guide for Businesses

Investing in real estate seems like a great way to build wealth. There are dozens of stories that still tout real estate investing as the best way to make money.

At the same time, there are a lot of unknowns and a lot of risks. There are also capital gains taxes and other tax rules to navigate. Those taxes could eat up a good percentage of your profits.

You can use a 1031 exchange, but you have to do so within the rules and timeframe. Read on to learn more about this option and the 1031 exchange timeframe so your transactions are successful.

Why Use 1031 Exchange?

When you sell a real estate property, there’s a good chance that you’ll sell it for a price that’s higher than what you bought it for. Housing prices have been going up over the last few years, making it likely that you’ll see a profit.

That profit is called capital gains.

The IRS requires that you pay taxes on capital gains, whether it’s for a real estate investment, stocks, bonds, or artwork.

How much taxes you need to pay depends on how long you hold on to the asset and which income tax bracket you’re in.

If you only hold on to a property for a year, the capital gains will be higher, up to 37%. The capital gains maximum tax rate is 20% for assets held for over a year because it’s considered to be a long-term investment.

The IRS code has a section, called section 1031 that allows you to defer capital gains taxes for real estate sales. You roll the proceeds of the sale of your property into another property.

1031 Exchange Timeframe and Rules

A 1031 exchange might seem like a great way to avoid taxes. You only get to defer taxes, not avoid paying them altogether. You would have to keep buying replacement properties if you wanted to avoid paying taxes altogether.

Think of a 1031 exchange as a tool that you can use to lower your tax burden. You can be strategic about when to use it and when you should realize the capital gains and pay taxes on them.

In order to make a 1031 exchange work, you have to have the transactions meet the IRS’ requirements and all within their timelines. Here are the main rules and the 1031 timeframe.

Property Must Be Like-Kind

The first rule to know about 1031 exchanges is that the properties have to be like-kind. There is a lot of leeway around this. You can have an empty lot and exchange it for a multi-family home.

The value of the properties does need to have a similar value or the replacement property has to have a higher value.

You might be wondering why you haven’t heard of this option as a homeowner who’s bought and sold properties. A 1031 exchange only applies to properties that are for business or investment purposes only.

A residential property does not qualify, like your primary residence or vacation home.

1031 Exchange Timeframe

The 1031 timeline is often the most challenging part of the entire transaction. You need to make sure that you understand when properties need to be identified and purchased and file the paperwork with the IRS.

When you sell your property, the timeline begins. There are 45 calendar days to find a replacement property. You then have 180 calendar days from the sale of your property to close on the sale of the replacement property.

If you purchase sell a property and April 15th (or whichever day is Tax Day) falls within the 180 day period, you have to complete the purchase by April 15th.

If it’s impossible to close the deal in a shorter timeframe, you can file a tax extension. If you owe other taxes, you still have to pay what you owe by April 15th. If you file an extension and pay your taxes later, you will be charged penalties and interest.

You Can’t Do a 1031 Exchange by Yourself

As you can tell, there are a lot of potential issues with a 1031 exchange. If you miss any of the deadlines, you will have to pay capital gains taxes.

You have to use a firm, or a person called a qualified intermediary. They are the holders of the proceeds of the sale of your initial property and help you handle the paperwork required.

The thing to remember is that they handle the money. The moment any funds from the sale of the property are in your hands, you have to pay taxes on them.

What Happens When You Want to Exit Real Estate?

For many property owners, they’re doing the maintenance and management of the properties themselves. Being a landlord is challenging.

At some point, you’re going to want to get out of real estate. Do you sell your properties altogether and pay capital gains taxes?

There may be a way to realize the benefits of a 1031 exchange, retire as a landlord, and see regular real estate income. That’s through a Delaware Statutory Trust or DST. These reasons explain why you want to explore this option.

Understanding Capital Gains Deferments

Taxes are complicated. They’re even more complicated when you’re dealing with investments like real estate. You can defer your real estate capital gains by leveraging a 1031 exchange. This lets you sell one property and purchase another without paying capital gains taxes right away.

You have to understand the 1031 exchange timeframe. If you can remember 45 days and 180 days, that’s half the battle. If Tax Day, falls in the middle of 180 days, do everything you can to finalize the purchase by then.

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