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How To Do A 1031 Exchange [What EVERY Investor Should Know] - YouTube
Channel: Tyler Cauble
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today we're going to discuss how to do a
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1031 exchange
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what it is why you should utilize this
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strategy
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and a couple of things you should keep
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in mind real estate markets are evolving
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constantly so it's important to review
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your portfolio frequently as new
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opportunities become available and is
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your financial objective shift
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if you're a real estate investor and
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thinking about either buying or selling
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property
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it's important to be familiar with the
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1031 tax deferred exchange
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which allows you as the property owner
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to sell one of your properties
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and acquire a different property while
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pushing off or deferring
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capital gains taxes capital gains taxes
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can reach
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up to 20 percent for those in the
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highest income bracket so this tax
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deferment tool can be an effective
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investment strategy as you buy
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and sell properties so first what is a
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1031 exchange a 1031 exchange gets its
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name from
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section 1031 of the irs code which says
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no gain or loss shall be recognized on
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the exchange of real property held for
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productive use in a trade or business
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or for investment if such real property
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is exchanged
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solely for real property of like kind
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which is to be held either for
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productive use in a trade or business or
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for
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investment and that's quite a sentence
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so to put it simply this
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code allows you to avoid paying capital
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gains taxes when you
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sell a property and invest those
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proceeds into a property of equal or
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greater value
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if you locate and purchase that new
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property within the designated time
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frame
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let's say you bought a property years
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ago for two hundred thousand dollars and
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put up a 20
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down payment which was 40 grand you've
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decided to sell that property which is
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now worth
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four hundred thousand dollars and so
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after paying your mortgage
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and all expenses you walk away with a
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hundred thousand dollars
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now you can buy a five hundred thousand
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dollar property with twenty percent down
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without coming out of pocket
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anyone who owns property held for
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business use or investment purposes
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qualifies for a 1031 exchange while
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personal residences
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and the majority of fix and flips do not
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qualify for this type of tax deferment
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so why would an investor
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utilize the tax 31 exchange well there
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are actually a number of reasons that
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make 1031 exchanges very attractive to
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investors
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number one improved cash flow if you
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have a high
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equity property or one that is free and
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clear it may be a good time to take that
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equity and invest it into a property of
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higher value where you can improve the
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cash flow
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the 1031 exchange actually allows you to
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reinvest the proceeds of your sold
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property into a newer
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more expensive property so you could use
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that equity that you've built up in your
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first property and place it into a
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different investment that will offer
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greater cash flow without you having to
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pull out that cash
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number two easier management if you have
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acquired multiple assets over the years
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such as a portfolio of single-family
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homes
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you may want to exchange them for
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something that requires less hands-on
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management such as a
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well-managed multi-family property we've
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had a number of clients that started
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their investing careers in the single
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family realm that we were able to help
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1031 exchange into large commercial
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properties that
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not only improved their cash flow but
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allowed them to afford
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full-time property management at a much
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lower cost
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number three estate planning if you are
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estate planning
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having a well-managed property will be
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far less of a hassle for your heirs to
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deal with since
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they may lack experience in real estate
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and would struggle with the property
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management responsibilities
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you may also desire to consolidate
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multiple assets into one
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or take a single asset and divide it
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over multiple properties
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for example if you own a large office
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building and want to pass your cash
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flowing asset
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down to your grandchildren it may be
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difficult to divide a singular asset
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among a handful of people instead it
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would be better and less complicated to
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have
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multiple properties that you could
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assign to each grandchild
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number four diversification don't put
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all of your eggs
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in one basket it's very beneficial to
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have a diversified portfolio you're
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allowed to utilize the 1031 exchange to
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purchase in different regions of the
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country or into multiple different types
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of assets
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if you own a single retail property you
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may be nervous for the future of the
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retail market as a whole
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so it would be wise to reposition your
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equity in this singular asset
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and distribute it across multiple
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markets that way if one isn't performing
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adequately you aren't left
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high and dry number five buying a
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vacation home
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that's right the 1031 exchange actually
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allows you to invest the proceeds from
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one of your investment properties into a
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vacation home that you and your family
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can enjoy
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but of course there are a few rules for
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this type of exchange as well
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the property being relinquished must
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have been held for at least 24 months in
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order to buy a vacation home and defer
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those capital gains taxes
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you must also rent this property out to
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another person for 14 days
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during every 12 month cycle you can
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however rent those 14 days out to a
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family member
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as long as the rental rate is at fair
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market value
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now here's how to do a 1031 exchange
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there are a number of rules to follow
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when executing a 1031 exchange so
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here's how to do it it's extremely
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important for you to be aware of what
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you can and
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cannot do according to irc 1031 in the
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irs tax code
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in order to ensure that you receive the
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full benefits of a 1031 exchange
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as a general rule for enjoying full tax
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deferral
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a taxpayer must reinvest all net
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exchange proceeds and acquire another
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property with the same or
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greater amount of debt so after you've
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sold the original property you have a 45
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day identification window
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this transaction must adhere to the
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allowed time frame of the irs section
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1031 code
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in order for your exchange to receive
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those benefits within 45 days of selling
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your asset
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you must identify a like-kind
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replacement property for these assets so
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what does like kind
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mean like-kind property simply means
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that real estate must be
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exchanged for real estate you cannot
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sell real estate and buy an airplane
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you can exchange a vacant piece of
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industrial land for a class a office
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building or trade two
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single-family homes as long as they were
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investment properties for a retail strip
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center but you cannot use a 1031
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exchange to do something like
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buying shares in the stock market with
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the proceeds from a quadplex
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the property must be held for investment
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or business purposes and cannot be used
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for personal uses or immediate resale
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although it determines an immediate
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resale is somewhat of a boring line
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if it is clear that there was no
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intention to flip immediately you could
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potentially trade the property the day
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after your purchase if your initial
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intention was to acquire the property as
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an investment
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although those situations are rare now
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there are a couple of rules that you
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have to follow when identifying your
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replacement property so let's dive into
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those
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the three property rule the three
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property rule allows you to identify
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up to three properties as potential
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replacements for your sold property no
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matter what their value is
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selecting the maximum amount of
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potential replacement properties is
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almost always the best course of action
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so you have multiple options in case one
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property ends up
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not working out the 200 rule the 200
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rule allows you to assemble four or more
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potential replacement properties
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as long as their total value does not
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exceed 200 percent
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of the value of your sold asset now
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after the identification period has
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expired you have 180 days
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to close on that new property within 180
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days of closing on the sale of your
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previous asset
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you have to complete the purchase for
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the replacement property during the 180
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day time frame you are also allowed to
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do construction on the property or make
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improvements as long as they are
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complete
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before the 1031 exchange deadline any
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improvements made
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after that 180-day period are viewed as
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personal property and will
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not be considered a part of your
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exchange now there are also a few
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variations of the 1031 exchange the most
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common which we have been discussing is
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often referred to as the delayed
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exchange but most people just call it
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the 1031.
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you could also do a simultaneous
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exchange where both properties are
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traded at the exact same time in the
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same escrow office a reverse exchange
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where you acquire
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a new property and then sell your
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original one or an improvement exchange
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which can be used for heavy renovations
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or new
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construction but what happens if you
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identify a property of lesser value and
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you can't find anything else well that's
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called a cash boot
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if your replacement property is of
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lesser value than the original asset you
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sell
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the difference can be taxed the presence
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of a mortgage is allowed on either side
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of a 1031 exchange but
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if the mortgage on the replacement is
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less than the property being sold this
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can also cause a cash boot now this cash
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boot can also be created by some fees
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associated with real estate transactions
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but
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fees such as broker commissions
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attorneys fees title insurance premiums
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escrow fees and filing fees those are
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included in the list of fees that can be
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paid with exchange funds
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now for the fun part reporting to the
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irs once the exchange is complete you
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will need
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to report the exchange to the irs using
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the form 8824
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in the same year in which the exchange
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took place form 8824 will ask you to
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provide information
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including property descriptions
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relationships between parties property
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values profit and loss cash received and
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more
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now you're probably wondering to
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yourself who handles the reporting to
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the irs and
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how would you identify these properties
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well that's where a qualified
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intermediary comes into play the
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qualified intermediary or
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qi works on your behalf as the
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facilitator for a 1031 exchange
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they receive and hold the proceeds from
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the relinquished property and then use
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those to acquire a newly identified
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property
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therefore it's very important that you
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choose wisely when it comes to qualified
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intermediaries
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unfortunately there isn't much
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government oversight in how qis are
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regulated and there aren't any
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educational or
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licensing requirements even the
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slightest error could disqualify you
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from receiving the benefits of a 1031
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exchange so
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it's wise to choose a qi who is
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knowledgeable and experienced in section
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1031 of the irc
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some questions to consider when choosing
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a qi how big is the company
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you may want to consider working with a
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larger team so that if there is an
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emergency there will be more than one
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person that will be able to assist you
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it can be devastating if something
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happens in your 1031 exchange falls
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through
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of no fault of your own does the qi you
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are choosing carry
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errors and omissions and fidelity
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insurance if the intermediary makes a
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mistake you will want to make sure you
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are covered
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fidelity insurance will cover any
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financial loss incurred from fraudulent
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activity that is performed by the
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intermediary company
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you should also ask them how your funds
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will be handled between the sale of your
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old property and the purchase of your
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new one unfortunately there have been
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cases of separate funds being commingled
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and used for investment activities which
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can leave sellers down the creek without
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a paddle you will want to make sure that
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your money is only being held for the
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purposes of executing the exchange so
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that you have a
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smooth transaction when the time comes
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to purchase that new property
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so before you get started it's critical
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to consult with your legal and financial
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advisors along with your real estate
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agent and all
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other appropriate parties that will be
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involved in this process
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time is of the essence in a 1031
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exchange so it is
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crucial that you have a solid plan in
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place and that you communicate this plan
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to
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all those with whom you'll be working
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with before you move forward now
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investors are able to successfully
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complete a 1031 exchange on their own
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however this process is very complicated
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and involved so it is crucial to work
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with experienced people that will be
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able to lead you through each step
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and ensure that you will execute it
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successfully so that's all we have for
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how to do a 1031 exchange
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if you're interested in learning more
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about commercial real estate investing
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check out this playlist here don't
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forget to like this video and subscribe
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