If you have an investment property in Arizona or anywhere in the United States and planning to sell it to buy another property, you should know about the 1031 Exchange Arizona. This is a method that allows the owner of investment property to sell it and buy like-kind property while deferring capital gains tax. Here, we will give you the summary key points of the 1031 exchange – concepts, rules, and definitions you must know if you are thinking of getting started with section 1031 of IRC.
What is a 1031 Exchange?
Section 1031 of the U.S. IRC (Internal Revenue Code), gave the name 1031 exchange. This enables an investor to abstain from paying capital gains taxes when the investor or taxpayer sells an investment property and reinvest the proceeds from the sale within certain time limits in a property or properties of like-kind and equal or greater value.
The Role of Qualified Intermediaries in a 1031 Exchange
Under section 1031, the returns received from the sale of the property remain taxable. Thus, the returns from the sale of the property must be transferred to a QI, rather than the seller of the property, and the QI transfers them to the seller of the replacement property. A qualified intermediary is a company or a person that facilitates 1031 exchanges by keeping the proceeds used in the transaction until the replacement property is acquired. The QI should have no formal relationship with the exchanging property parties.
Situations when you can do a 1031 Exchange –
As an investor or taxpayer, there are numerous reasons for an investor to consider utilizing a 1031 exchange. Some of the reasons are explained below:
- An investor can acquire a property that shows better return prospects and may look to diversify assets.
- Property owners always look for a managed property rather than the one to be managed by himself.
- An investor may want to consolidate several properties into one, for purposes of real estate planning, or they may want to disintegrate a single property into several assets.
- Reset the depreciation clock (explained below)
The main advantage of carrying out a 1031 exchange rather than selling one property and buying another is the tax deferral. A 1031 exchange allows the investor to defer capital gains tax, thus liberating more capital for investment in the replacement property.
It is important for an investor to keep in mind that a 1031 exchange may ask for high minimum investment and holding period. That’s why it’s more suitable for individuals with greater net worth. Plus, because of complexity, 1031 exchanges are often handled by professionals.
Closing replacement properties –
Like-kind property is defined according to its attributes or nature, not its grade or quality. This means that you can choose a wide range of properties for your 1031 exchange. You can exchange an income-producing land for a commercial building or a multi-family apartment for an industrial property or vice-versa. However, you may not be able to exchange primary residence for commercial property because it does not meet the like-kind definition. 1031 exchange properties must be held for business purposes, not resale or personal use. You may need to hold a property for a minimum of two years.
To qualify for a 1031 exchange, the replacement property needs to be of equal or greater value. You must identify a replacement property within 45 days and then close the transaction within 180 days. Property rules that need to be followed to under property identification are as follows. You must abide by one of the following rules:
- The three-property rulelets you identify three properties as potential purchases regardless of their market value.
- The 200% rule allows the investor to identify unlimited replacement properties as long as the total value does not exceed 200% of the value of the property sold.
- The 95% rule allows the investor to identify as many properties as he wants as long as he acquires the property valued at 95% of their total value or more.
Different Kinds of Like-Kind Exchanges
There are many possibilities for making 1031 exchanges that differ in their timing and other details, each creating a set of prerequisites and procedures that have to be followed:
- 1031 Exchanges that are carried out within 180 days are commonly known as delayed exchanges since, at a single time, exchanges had to be performed simultaneously.
- Build-to-suit exchanges allow the 1031 Exchange replacement property to be newly constructed or renovated. However, these kinds of exchanges are yet subject to the 180-day rule, meaning all construction improvements must be finished by the time the exchange is finished. Any improvements made later are considered personal property and would not qualify as part of the exchange.
- When the investor acquires the replacement property before selling the property to be exchanged, it is called a reverse exchange. It is the case when the property must be transferred to an exchange accommodation titleholder, i.e., the qualified intermediary and a qualified exchange accommodation agreement is signed. Within 45 days of the transfer of the property, the identification of the property for exchange must be made, and the transaction for it must be carried out within 180 days.
Hence now we have an overview of the basics of 1031 exchange, the role of qualified intermediary in 1031 exchange, timeline and rules for replacement property, and like-kind exchanges. You can also invest in DSTs using 1031 DST exchange. It’s recommended you consult 1031 exchange experts before investing. All the information above is researched and thought to be knowledgeable for you.