The Nest

NestApple's Real Estate Blog

Featuring real estate articles and information to help real estate buyers and sellers. The Nest features writings from Georges Benoliel and other real estate professionals. Georges is the Co-Founder of NestApple and has been working as an active real estate investor for over a decade.

How to do a 1031 Exchange in NYC

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This post will teach you how to execute a 1031 exchange through exploring

INTRODUCTION:

A 1031 exchange, also known as a “Like-Kind” exchange or a “Starker Exchange” is a formidable tax-deferment strategy that savvy investors use in real estate dealings.

In 2018, 1031 exchanges are more and more common due to the perceived housing bubble developing; thus, more and more people are looking to sell property, make money, but not be taxed on this money.

Therefore, if you are looking into what a 1031 exchange is, thinking about executing one, look no further and continue reading!

WHAT IS A 1031 EXCHANGE?

First let’s break down the name:

    1. The term 1031 comes from where the exchange is found in the IRS tax code, section 1031.
    2. The “exchange” part comes from taking capital gains from the sale of a property and putting that money into a like-kind” property without paying taxes on those capital gains. (We will discuss what constitutes a “like-kind” property below.)
    3. Originally, the exchange came from literally trading your property for someone else’s, straight up – today called a “simultaneous” exchange. However, not only is that rare, most 1031 exchanges are “delayed” 1031 exchanges, which is the exchange we will be discussing in this post.

However, there are different types of exchanges, so let’s explore one other relevant type before tackling the most common – “delayed exchange” – one.

Improvement/Construction Exchange

This exchange comes in handy when you want to make improvements to an acquired property with the capital gains of your previous property without paying taxes on that money. There are a few rules with this exchange.

  1. The total exchange equity has to be used on the completion of the property by the 180th day
  2. If the money is not used for completed construction by the 180th day it must have been used for a down payment on the property

RULES OF A 1031 (DELAYED) EXCHANGE

When most people talk about a 1031 exchange, they are talking about a “delayed” exchange. But, like most things, there are rules and regulations you must follow in order to execute a 1031 properly.

1. LIKE-KIND PROPERTY

The property you are putting the capital gains into must be of a “like kind”. The IRS describes a “like-kind property” as one “of the same nature, character or class. Quality
or grade does not matter. Most real estate will be like-kind to other real estate. For
example, real property that is improved with a residential rental house is like-kind to vacant land”. In other words, you cannot relinquish machinery and use that money to fund a replacement apartment building.

But you could exchange:

  • A single family home for an office building.
  • A multi-family complex for a rental home. And much, much more.

Bottom line is the IRS is pretty lenient as far as what a like-kind property is as long as it is a property.

An important note: All properties must in the exchange be a U.S. property not from a foreign country.

2. EQUAL OR GREATER VALUE

If the hope is to pay absolutely no tax on your capital gains, the IRS demands the (net) market price of the property plus any equity be the baseline for your next property.

For example, let’s say you are selling a $1 million home with a mortgage of $250,000. The “like-kind” property must be at least $1 million in value and you will have to carry over the $250,000 mortgage. Any brokerage fees, real estate taxes, also factor into this number.

3. INVESTMENT OR BUSINESS PROPERTIES ONLY

This rule is self-explanatory but the one most people get tripped up on. The most common is you cannot swap primary residences. For example, let’s say you are moving from Wyoming to New York, you cannot swap your primary residence in Wyoming for a new one in New York. However, let’s say you own a rental property in Arizona you can swap that for a vacation house in California (again of equal or greater value).

NOTE: there are a few other types of property which do not fall under a 1031 such as:

  • Land under development
  • Inventory property
  • Property held for resale
  • Notes and bonds

4. SAME TITLE NAMES

Simply put, the relinquished property title names need to be the same on the acquired replacement property.

For example, if a husband and wife own a home and are trying to execute a 1031 exchange for a new home, they both need to be deeded on the new property. This is the same of LLC.’s, corporations, etc. The titles need to match regardless.

Again a simple rule, however, one that stops some 1031 exchanges from going through.

5. THE BOOT RULE

Let’s say you want to execute a 1031 exchange that is of lesser value. “Boot” is what the difference between the relinquished property and the replaced property is called. And that difference is taxable.

This often happens when an investor wants to make money and is okay paying some taxes on the gains.

For example, let’s say you want to sell that $1 million property but the replaced property is only worth $750,000. The $250,000 is taxable.

6. THE 45 DAY RULE (IDENTIFICATION RULE)

Another rather simple rule that states, post-closing the relinquished property, the investor has 45 days, calendar not business, to identify up to three like-kind properties. The key here is that they have to hit the requirements above monetarily speaking.

This can become a challenge for some investors because often properties are over-priced meaning that when they ultimately close, the EQUAL OR GREATER VALUE rule may not be satisfied.

NOTE: This rule is nullified if one follows the 200% rule. This is when you can identify four or more properties if they do not add up to 200% of the relinquished property value.

7. THE 180 DAY RULE (PURCHASE RULE)

This regulation states that the property purchase and exchange must be completed in under 180 days or the due date of the tax return for that tax year (with extensions) in which the property was sold, whichever is earlier.

In other words, if the 180 day limit is after when taxes are due, the exchange must close by the tax return due date not whenever 180 day limit is.

 

 

NOTE: There is never any extensions on this 180 day limit. If the exchange is not completed within these time frames, the exchange is null and void.

WHEN COULD A 1031 EXCHANGE BENEFIT ME

If you are currently investing in a property that you are looking to sell, this would be perfect for you. To be able to sell a property and put that money directly back into another investment property, all without paying taxes, not only saves you money, but allows you to invest in a property that may otherwise be beyond your budget.

 

WHY IS A 1031 EXCHANGE BENFICIAL IN THE SHORT RUN AND LONG RUN

In the short run, executing a 1031 exchange could help you invest in a bigger and better property right now.

But, in the long run, these 1031 exchanges could be even more advantageous. The more you sell and then put your tax-free money back into a property investment, theoretically, the more properties you can invest in.

For example, if you execute a 1031 exchange on a single family home and use that tax-free money to invest into another bigger property, let’s say a two family rental home, you are now collecting more passive income than you were before. This cycle could continue and give you (and your partner/company) more assets down the road.

HOW TO DO A 1031 EXCHANGE NOW?

If you believe that you are ready to sell an investment property (and have the foresight of another property you may want or location for a property), hire professional help: broker to execute the sale and purchase and attorney to structure itNestApple is here for you and you will save:

  • 2% cash back on your purchase
  • 1.5 to 3% on your sale

While this is an incredible rule in the IRS code, even life-long real estate investors need assistance. However, once assistance is acquired, the process is usually quite smooth.



Georges Benoliel Founder of NestApple - NestApple NYC cashback rebate

Georges Benoliel

Georges has been working in Wall Street for the last 16 years trading derivatives with hedge funds. He has been an active real estate investor for over a decade. Georges graduated from HEC Business School in Paris and holds a master in Finance from ESADE Barcelona.