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1031 exchange rules are important to understand if you have an investment property. A 1031 exchange provides a method of rolling over the proceeds you receive from selling an investment property to the purchase of another investment property. In comparison to selling a piece of real estate traditionally, the 1031 allows for a third party to receive the funds from the sale. This third party is called the "facilitator" or sometimes the "qualified intermediary." The funds from the sale of the investment are held by the intermediary until the purchase of a new piece of real estate is made. This sometimes complex method does offer benefits. 1031 exchange rules allow you to defer paying capital gains taxes when you purchase a "like-kind" investment property. In other words, when you use this type of arrangement, you are getting an interest-free loan on the money you would have been paying in taxes. One of the nice benefits of the 1031 exchange rules is that the set-up allows for the property-owner to move from one property to a larger property each time this method is used. They get to hold on to the equity they have built and leverage it in purchasing other properties, increasing cash flow and saving money otherwise needed for interest on loans, which are often needed with the traditional "buy-and-sell" scenario. The 1031 exchange rules do dictate that the only type of property that can use this type of scenario is property that is an investment property. Private residential properties are unable to use this scenario. Additionally, you are required to purchase a "like-kind" property with the proceeds of the sale. The terminology here is often a little confusing. By definition, these terms mean that you will exchange real property for real property. This does not mean it has to be rental property for rental property. For example, you could sell a single property and purchase multiple properties with the proceeds. Both properties (the one sold and the one purchased) must be held by the investor for use in trade or as an investment. Any proceeds that are not used in the purchase of the second property are taxed as if the property were sold as a cash sale. Understanding 1031 exchange rules is essential if you will be using this method to purchase your next investment property. Because of the complexities and the possible tax scenarios, it is advisable to work with your attorney and a tax professional. Some real estate agents may be able to help set up this process as well.
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