5 Professionals Behind a Successful 1031 Exchange

When embarking on a 1031 Exchange, it's crucial to assemble a team of professionals who can guide you through the process and maximize the benefits. These experts possess the knowledge and experience necessary to ensure a successful exchange that aligns with your goals. Here are five professionals who play key roles in facilitating a smooth and effective 1031 Exchange:

Qualified Intermediary (QI): A QI is a crucial player in a 1031 Exchange. They facilitate the sale of your relinquished property, hold the funds in a segregated account, and assist in identifying and acquiring replacement properties within the specified timelines. Their expertise ensures compliance with IRS regulations.

Real Estate Agent/Broker: Engaging a knowledgeable real estate agent or broker can help you find suitable replacement properties that align with your investment objectives. They have access to market data and can guide you through the purchase process while considering your specific requirements.

Tax Advisor/Accountant: A tax advisor or accountant specializing in real estate can provide valuable insights into the tax implications of your exchange. They can help you understand the tax deferral benefits, assess your eligibility for various tax strategies, and ensure compliance with tax laws.

Real Estate Attorney: A real estate attorney familiar with 1031 Exchanges can offer legal guidance and help navigate any complex legal issues that may arise during the process. They ensure the transaction adheres to local laws, review contracts, and provide guidance on potential liabilities.

Financial professional: A financial professional can provide investment insights targeting your investment goals. They can help evaluate the financial impact of the exchange, assess the long-term implications, and strive to ensure your investment strategy aligns with your overall financial objectives.

By assembling a team of professionals, including a Qualified Intermediary, real estate agent/broker, tax advisor/accountant, real estate attorney, and financial professional, you can benefit from their specialized expertise and ensure a successful 1031 Exchange. Working collaboratively, they will guide you through the process, strive to mitigate risks, and attempt to help you achieve your investment goals.

A licensed 1031 Exchange professional 

A licensed 1031 Exchange professional serves as the team captain in the 1031 Exchange process. They possess expertise in the Exchange process, tax code, strategies, and replacement property options. As the team leader, they provide consultation, develop Exchange strategies, assist in selecting and acquiring replacement properties, and guide clients through the 8 key steps of the Exchange process while ensuring compliance with IRS rules.

Quality 1031 Exchange professional often have CPAs on staff to calculate tax liabilities and estimate financial projections for replacement properties. They continuously analyze and evaluate replacement properties to find high-quality options that align with client objectives.

Additionally, a good 1031 Exchange professional collaborates closely with other professionals involved in the Exchange, such as real estate agents, tax advisors, attorneys, and financial professionals. This collaboration ensures a smooth and seamless transition throughout the Exchange process, maximizing the chances of a successful outcome for clients.

A Qualified Intermediary (QI)

Purchase agreement for a new house indicating the role of a qualified intermediary in a 1031 exchange for tax deferral

A Qualified Intermediary (QI), also known as an Exchange Accommodator or Exchange Facilitator, is an independent entity that plays a crucial role in a 1031 Exchange. The QI holds the funds from the sale of the relinquished property and facilitates the acquisition of the replacement property.

To comply with IRS requirements, the exchanger must identify a qualified intermediary and establish an "Exchange" with them prior to closing on the sale of the relinquished property. The QI prepares the necessary documents for the Exchange and ensures that the funds are properly handled during the transaction.

When selecting a qualified intermediary for your 1031 Exchange, it is important to consider their reputation, transaction history, and experience in handling exchanges. Additionally, verifying that the QI has errors and omissions insurance, as well as fidelity insurance, is crucial for added protection.

Choosing a reputable and reliable qualified intermediary is essential to ensure a smooth and compliant 1031 Exchange process.

Real Estate Broker

Male real estate broker shaking hands with new property owners highlighting the role of a 1031 exchange in tax deferral

Working with a real estate broker who has experience with 1031 Exchanges can be highly beneficial when selling your relinquished rental property. These brokers have a deep understanding of the time-sensitive nature of exchanges and can take additional steps to safeguard your exchange.

A real estate broker with 1031 Exchange experience will be familiar with the intricacies of the exchange process and can provide guidance throughout the transaction. They may include a 1031 Exchange Cooperation Clause in the purchase and sale agreement, which helps protect your exchange by ensuring all parties involved are aware of the exchange and will cooperate accordingly.

By collaborating with a real estate broker who specializes in 1031 Exchanges, you can benefit from their knowledge and expertise, ultimately increasing the likelihood of a successful exchange.

CPA / Tax Advisor:

Engaging a CPA or tax advisor with expertise in 1031 Exchanges is crucial to ensure the tax implications of your exchange are properly addressed. They can help align your financial goals with the exchange strategy, provide guidance on tax planning, and ensure compliance with IRS regulations. Your tax advisor will gather the necessary documentation and report the 1031 Exchange on your tax return.

Attorney:

While not always necessary, hiring a real estate attorney for your 1031 Exchange can be beneficial, particularly in complex situations such as co-ownership or legal entity restructuring. A real estate attorney with experience in 1031 Exchanges can provide legal guidance, review contracts, and ensure compliance with applicable laws. They can also coordinate with other professionals involved in the exchange to ensure a smooth process.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

Understanding DSTs: Leveraging Them for 1031 Exchanges

Understanding DSTs: Leveraging Them for 1031 Exchanges

DST stands for Delaware Statutory Trust, a legal entity established according to Delaware law. It is important to note that the property and investors associated with a DST are not required to be situated in Delaware. In a DST, every investor possesses a stake in the Trust, which ultimately holds ownership of the property.

These investors are referred to as "beneficiaries" of the Trust. Consequently, the ownership rights held by investors in a DST are known as "beneficiary interests." Notably, the Internal Revenue Service (IRS) treats DST beneficiary interests as equivalent to direct property ownership, thereby making them eligible for a 1031 exchange.

1031 Exchange Explained

Financial advisor explaining 1031 exchange and Delaware Statutory Trust to a couple

A 1031 exchange is a tax deferral strategy widely employed by real estate investors to optimize their investments. It entails utilizing the proceeds obtained from the sale of an investment property to acquire another property that is considered "like-kind" in the eyes of the tax code.

By engaging in a 1031 exchange, investors can defer the payment of capital gains taxes that would typically arise from the sale of their assets. This allows them to retain a larger portion of their proceeds from a sale, facilitating the creation of a more diverse investment portfolio.

In the context of Delaware Statutory Trusts (DSTs), 1031 exchanges present a unique opportunity to expand one's investment horizon and potentially access high-value properties. DSTs offer a vehicle for investors with limited funds to participate in the ownership of premium commercial properties, such as retail spaces, apartment complexes, and industrial facilities. By pooling their resources together in a DST, individual investors gain the ability to collectively acquire these sought-after properties.

Once an investor becomes a beneficiary in a DST and holds passive ownership in a high-dollar property, the benefits of a 1031 exchange continue to play a significant role. By leveraging subsequent 1031 exchanges, investors can defer their tax liabilities and effectively roll their investment gains into additional high-end assets. This strategy enables them to perpetuate the growth of their investment portfolio while deferring the payment of capital gains taxes until a future date.

DST’s Explained

In order for a Delaware Statutory Trust (DST) to qualify under Section 1031 for a like-kind exchange, there are key guidelines set forth by the IRS. These guidelines include:

1. Unlimited Beneficiaries: While the number of beneficiaries in a DST is generally capped at 499 in practice, there is no strict limit imposed by the IRS.

2. Trustee Decision-Making: The Trustee of the DST is responsible for making material decisions, rather than the individual investors. This structure ensures a centralized decision-making process.

3. Passive Real Estate Holding: The DST operates as a passive holder of real estate. Trustees have limited powers, and beneficiaries (investors) do not have authority over property operations.

The DST structure offers several structural advantages, including:

Old weighing scale representing the advantages of Delaware Statutory Trust (DSTs) in a 1031 exchange

1. Limited Liability: Similar to a limited liability company (LLC) or corporation, the DST structure protects investors from personal liabilities beyond their investment amount.

2. Bankruptcy Protection: The DST structure safeguards individual investors from creditors pursuing the DST's debts. It also prevents investors from placing liens on the DST's property, providing additional protection to mortgage lenders and other beneficiaries.

3. Centralized Control: Major decisions within the DST are made by a single Trustee, eliminating concerns or disagreements among investors.

4. Single Borrower: The DST acts as the sole borrower and owns 100% of the property. This simplifies the process of obtaining a mortgage, as there is no need to coordinate multiple borrowers.

5. Permissible Number of Investors: DSTs can accommodate a large number of beneficiaries, with no strict limit imposed by the IRS (though it is typically capped at 499). This allows for the purchase of institutional quality properties, spread across a larger number of investors, and provides the advantage of lower investment minimums.

6. Pre-Packaged Investments: DSTs often offer pre-acquired properties with mortgages already in place. This simplifies the investment process for investors using 1031 exchange funds, as they can easily purchase fractional DST investments without the complexities of property acquisition and mortgage arrangements.

These guidelines and structural advantages make DSTs an attractive option for investors seeking the benefits of a like-kind exchange while enjoying limited liability, centralized control, and access to institutional-grade properties.

While the Delaware Statutory Trust (DST) structure offers numerous advantages, it is important to note the limitations that must be considered for qualification in a 1031 exchange. These prohibitions include:

1. Capital Contributions: Once the DST is closed, investors are not permitted to make additional capital contributions to the trust.

2. Loan Terms: The Trustee of the DST cannot renegotiate the terms of existing loans or secure new funds through borrowing.

3. Proceeds from Property Sales: If a property owned by the DST is sold, the Trustee is obligated to return the proceeds to the investors rather than reinvesting them in another property.

4. Capital Expenditures: The DST is restricted in terms of capital expenditures it can make on its properties. These expenditures are typically limited to normal repair and maintenance, non-structural improvements, and those mandated by law.

5. Investment of Cash: Cash held by the DST between distributions to investors can only be invested in short-term debt securities such as US Treasury bills.

6. Cash Distribution: With the exception of reserves, all cash must be regularly distributed to the beneficiaries (investors).

7. Leases: The Trustee is prohibited from entering into new leases or renegotiating existing leases.

Despite these limitations, fractional property investments through DSTs remain an appealing option for investors engaged in 1031 exchanges. This structure enables investors to participate in larger, higher-quality assets that might be otherwise out of their reach. Additionally, the pre-packaged nature of DSTs simplifies the investment process and helps investors meet the strict timelines required for exchanges. It is worth noting that DSTs are generally best suited for investors seeking longer-term, passive investment opportunities.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

Is Gold Eligible for a 1031 Exchange?

Utilizing 1031 Exchanges for Tax Deferral in Investment: Exploring Property Eligibility and Limitations

Investors often aim to defer capital gains taxes through 1031 exchanges, which boosts funds for reinvestment and enhances investment leverage. Sequential exchanges have the potential to compound these benefits, helping to facilitate the possibility of portfolio growth. Some taxpayers have attempted to expand the scope of eligible properties, including collectibles, intellectual property, and valuable metals.

While stocks and securities do not qualify, certain items like coins, artwork, and antiques were occasionally eligible before the Tax Cuts and Jobs Act (TCJA). Nonetheless, even with looser regulations, the IRS imposed restrictions, such as disallowing gold-for-silver exchanges and gold coin-for-bullion exchanges.

TCJA Exclusion and IRS Rulings on 1031 Exchanges

Following the enactment of the TCJA, the scope of 1031 exchanges was narrowed down to exclusively include real estate. The IRS provided further clarification through rulings such as REG-117589-18, which outlined the statutory limitations on like-kind exchanges. According to this regulation, real property encompasses land, land improvements, unsevered crops, natural products of the land, and adjacent water and air space. It also encompasses permanent structures like roads and bridges.

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Understanding the Basics of a 1031 Exchange

A 1031 exchange is a valuable tool for real estate owners. It allows them to strategically shift their investments without incurring immediate capital gains taxes. Here's how it works:

In summary, a 1031 exchange allows you to defer capital gains taxes and reinvest the proceeds into another property, thereby seeking to maximize your investment potential.

Exploring Sequential 1031 Exchanges and Tax Deferral Strategies

While a 1031 exchange allows you to defer capital gains tax, it's important to note that the tax is not eliminated entirely. If you eventually sell the replacement property acquired through the exchange, you will owe capital gains tax on any profit from that sale. Additionally, you will also be liable for the deferred tax on the original asset.

However, there is a potential strategy to continue deferring the tax liability. By deferring the tax until the point of transferring the property to an heir through inheritance, it becomes possible to entirely avoid the capital gains tax. This is due to the concept of a stepped-up value for inherited assets.

When the property is inherited, the heir receives it at its stepped-up value, which is determined based on its worth at the time of the original owner's death. This stepped-up value becomes the new basis for the heir, and no tax is due for any gains that occurred prior to the inheritance.

By carefully planning and utilizing this strategy, investors can effectively defer their tax obligations through sequential 1031 exchanges and ultimately pass on the property to heirs, allowing them to enjoy the benefits of a stepped-up basis and avoiding capital gains tax on prior gains.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

·     There’s no guarantee any strategy will be successful or achieve investment objectives;

·     All real estate investments have the potential to lose value during the life of the investments;

·     The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·     All financed real estate investments have potential for foreclosure;

·     These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·     If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·     Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

 

Ensuring Your 1031 Exchange is Successfully Transacted

Selling investment or business real estate can be costly, but a 1031 exchange may help preserve gains and generate wealth. Under Section 1031 of the federal tax code, no gain or loss is recognized on the sale of a real estate property held for business or investment purposes if a replacement property of equal or greater value is purchased. However, the 1031 exchange process can be complex. To help guide your clients through a successful exchange, consider these steps:

Step 1

Be aware of the deadlines set by the IRS. Investors have 45 days to identify a replacement property and 180 days to close on it after selling the relinquished property. It may seem like a short time frame, but it is manageable with the help of a professional 1031 exchange investment firm such as Perch Wealth.

Step 2

The IRS requires that an exchanger reinvest in a “like-kind” property, but this does not necessarily mean the same type of property. There are various options available. For example, if you are selling a duplex, you don't have to replace it with another duplex.

The 1031 exchange allows investors to replace relinquished real estate with different types of assets such as a medical building, single-family home, multifamily apartment building, raw land, self-storage facility or any other investment real estate as long as it is held for investment or business purposes. It is best to know what you are looking for in a replacement property before going into escrow on the property you are selling.

Working with a 1031 exchange investment firm like Perch Wealth can greatly reduce the stress and confusion surrounding 1031 exchanges.

Step 3

It is not uncommon for 1031 exchange investors to feel overwhelmed and stressed when they reach the 30-day mark of their 45-day window without a replacement property identified for their exchange. However, with some planning and preparation, you can avoid this situation. A good strategy is to identify five to ten potential replacement properties as the closing date of the property you are selling approaches.

Keep in mind that some of these properties may be acquired by other buyers or may not be suitable after further evaluation, which is why it is important to have a short list of potential replacement properties before relinquishing the original asset. This can help prevent your 1031 exchange from falling apart.

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Step 4

It is not uncommon for investors to call in a panic because they have found a replacement property, but they are unable to secure financing to purchase it. To avoid this stressful and potentially costly situation, it is important to ensure that financing is in place before closing on the property being sold.

One solution is to consider fractional ownership structures for 1031 exchanges, such as a Delaware Statutory Trust (DST) investment for accredited investors. DSTs have a non-recourse financing component built-in, so the investor does not need to sign for a loan. This can make a DST an ideal opportunity for an investor looking for a passive, turn-key solution with pre-established financing for their 1031 exchange.

Step 5

According to the IRS code, investors have options for identifying replacement properties for their 1031 exchange. The most common methods are identifying three properties at any value or identifying real estate valued at up to 200% of the property being sold. This allows for back-up options.

It is important to take advantage of this opportunity and not leave any empty spaces on the ID form submitted to the qualified intermediary. Often, the primary option may not work out, and having back-up options can strengthen the investor's negotiating power by providing additional choices.

For accredited investors, a Delaware Statutory Trust (DST) can be an excellent back-up strategy. DST properties are already purchased, stabilized, and may provide monthly distributions to investors. There is no need for negotiation and due diligence is already complete.

Additionally, closing on a DST can often be done in three to five business days. It is a good idea to consider using a DST as a back-up ID if there is room in the exchange and it is appropriate for the investor's situation.

Step 6

When entering into a purchase and sale agreement, it is important to include a 1031 contingency clause. Many buyers are willing to allow a 1031 contingency that allows the seller to extend escrow on the property being sold if the seller is unable to find a replacement property. For example, try to negotiate a clause that extends escrow by an additional 30 days in case you are unable to identify a suitable replacement property. This can provide extra time if needed when locating the right 1031 exchange investment.

In summary, a 1031 exchange may be a valuable tool for potentially building and preserving wealth, but it can also be a challenging process if not properly prepared. To ensure a successful exchange, start early, educate yourself, narrow down options, secure financing, have a back-up plan, and negotiate for more time if needed.

For accredited investors, consider using a Delaware Statutory Trust (DST) as part of your 1031 exchange strategy. Keep in mind that there are no guarantees in real estate, so it is always best to plan ahead when considering a 1031 exchange.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

How do 1031 Exchanges Impact Real Estate Investors' Cash Flow?

A 1031 exchange, also known as a like-kind exchange, is a tax strategy that allows real estate investors to defer paying capital gains tax on the sale of a property by reinvesting the proceeds into a similar property. This strategy can have a significant impact on an investor's cash flow, as it allows them to retain more of the proceeds from the sale of the property and use it to purchase a new one.

A brief overview of how it impacts real estate investors' cash flow: When a property is sold, the investor is required to pay capital gains tax on the profit made from the sale. This can be a significant amount, especially for properties that have appreciated in value over time.

However, by using a 1031 exchange, the investor can defer paying this tax by reinvesting the proceeds from the sale into a similar property. This helps to preserve the investor's cash flow and allows them to use the proceeds to purchase a new property, which could generate more income or appreciate in value over time. Additionally, it can also help investors to diversify their property portfolios and avoid the concentration of assets in one specific area.

It's important to note that 1031 exchanges are complex transactions that are subject to strict rules and deadlines, and investors should consult with a tax professional before attempting one. But if done correctly, they can be an effective way to manage cash flow and grow wealth through real estate investments.

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How a 1031 Exchange Works:

A 1031 exchange is a process that allows real estate investors to defer paying capital gains tax on the sale of a property by reinvesting the proceeds into a similar property. However, there are several steps and guidelines that must be followed in order for the exchange to qualify for the tax deferment.

The first step in a 1031 exchange is the identification of the replacement property. Investors have 45 days from the sale of their original property to identify potential replacement properties. They can identify up to three potential properties, or any number of properties if their fair market value does not exceed 200% of the fair market value of the sold property.

Once the replacement property has been identified, the timing requirements for the exchange must be met. The investor must close on the replacement property within 180 days of the sale of the original property, or by the due date of their tax return for the year in which the original property was sold, whichever comes first.

The role of a qualified intermediary is critical in a 1031 exchange. The intermediary acts as a facilitator of the exchange and holds the proceeds from the sale of the original property until they are used to purchase the replacement property. The intermediary also helps the investor to ensure that all of the rules and guidelines for the exchange are met.

It's important to note that 1031 exchanges are complex transactions and investors must be aware of the rules and guidelines set by the IRS. Any mistake can disqualify the exchange, and investors should seek assistance from a professional to ensure that the exchange is done correctly.

Advantages of using a 1031 Exchange:

One of the main advantages of using a 1031 exchange is the deferment of capital gains tax. When an investor sells a property, they are required to pay capital gains tax on the profit made from the sale. However, by using a 1031 exchange, the investor can defer paying this tax by reinvesting the proceeds into a similar property. This can help to preserve the investor's cash flow and allow them to use the proceeds to purchase a new property.

Another advantage of using a 1031 exchange is the ability to reinvest proceeds into a larger or more profitable property. By deferring the capital gains tax, the investor can use the proceeds to purchase a more expensive property or one that has the potential to generate more income. This can be particularly beneficial for investors who are looking to grow their property portfolios and increase their wealth over time.

A third advantage of using a 1031 exchange is the potential for long-term wealth building. By deferring the capital gains tax and reinvesting the proceeds into a new property, the investor can potentially generate more income or capital appreciation over time. This can help them to build wealth through real estate investments over the long-term.

It's important to note that 1031 exchanges are complex transactions and investors should consult with a tax professional before attempting one. But if done correctly, they can be an effective way to manage cash flow, grow wealth through real estate investments, and diversify property portfolios.

Considerations for Real Estate Investors:

When considering a 1031 exchange, real estate investors must carefully consider their options and weigh the potential benefits against the potential drawbacks. One important consideration is choosing the right property for exchange. The replacement property must be of "like-kind" to the original property, meaning it must be used for the same purpose and in the same manner. It's important for the investor to identify a property that has the potential to generate more income or appreciate in value over time.

Another consideration is the strict deadlines and guidelines set by the IRS for 1031 exchanges. The investor must identify the replacement property within 45 days of the sale of the original property, and close on the replacement property within 180 days of the sale of the original property. If these deadlines are not met, the exchange will not qualify for the tax deferment.

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Another potential drawback of 1031 exchanges is that they can be costly. Investors may have to pay fees to a qualified intermediary and may also need to pay for legal and other professional services. Additionally, the replacement property may be more expensive than the original property, which can reduce the investor's cash flow.

In summary, 1031 exchanges can be an effective way to manage cash flow and grow wealth through real estate investments, but they are complex transactions that are subject to strict rules and deadlines. Real estate investors should carefully consider their options and consult with a tax professional before attempting a 1031 exchange. It's important to weigh the potential benefits against the potential drawbacks and to make sure that the replacement property is a good fit for the investor's goals and needs.

Conclusion:

A 1031 exchange, also known as a like-kind exchange, is a tax strategy that allows real estate investors to defer paying capital gains tax on the sale of a property by reinvesting the proceeds into a similar property. This strategy can have a significant impact on an investor's cash flow, as it allows them to retain more of the proceeds from the sale of the property and use it to purchase a new one.

The process of a 1031 exchange includes the identification of the replacement property, the adherence to timing requirements and the involvement of a qualified intermediary. The advantages of using a 1031 exchange include the deferment of capital gains tax, the ability to reinvest proceeds into larger or more profitable property and the potential for long-term wealth building.

However, 1031 exchanges also come with considerations such as choosing the right property for exchange, meeting strict deadlines and guidelines, and potential drawbacks such as higher costs and reduced cash flow.

In summary, a 1031 exchange can be an effective way to manage cash flow and grow wealth through real estate investments, but it's important to consult with a tax professional before attempting one, to weigh the potential benefits against the potential drawbacks, and to make sure that the replacement property is a good fit for the investor's goals and needs.

Additionally, it's important to remember that 1031 exchanges are complex transactions and investors must be aware of the rules and guidelines set by the IRS to avoid any mistake that can disqualify the exchange.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Understanding the Holding Period of a "Like-Kind" Exchange

There are strict timeframes that every investor must adhere to successfully complete a 1031 exchange. However, investors commonly ask, is there a certain amount of time that a property must be held to qualify for an exchange? While the IRS has not explicitly identified a holding period, a few considerations may offer insight.

The 1031 Holding Period

The holding period is how long an investor holds their property. As mentioned, Internal Revenue Code (IRC) Section 1031 does not define how long a holding period must be. Rather, it comes down to the intent of the investor.

The IRS explains: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”

“Properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality.

“Real properties generally are of like-kind, regardless of whether they’re improved or unimproved. For example, an apartment building would generally be like-kind to another apartment building. However, real property in the United States is not like-kind to real property outside the United States.”

Understanding Intent

Section 1031 is designed to enable investors who have held their property for an extended period of time – specifically, those who held the property for income-producing purposes – to trade into another property that would serve the same purpose.

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However, not all real estate qualifies because not all is held for the same purpose. The most common example to look at is a primary residence. Since a primary home is not “held for productive use in a trade or business or for investment,” it does not qualify for an exchange. On the other hand, apartment buildings, offices and medical complexes, retail centers and single-tenant assets generally qualify since they are held as an investment.

Developers also face challenges when trying to complete a 1031 exchange. Since a property must be held for investment purposes, buying land, building a property, and selling for a profit often disqualifies the transaction from a 1031 exchange. In this scenario, the property was held to resell for profit, not for investment.

However, investors should consider holding the property for at least one year, if not two, if they are uncertain the property will satisfy Section 1031.

While the IRS has never stated that there is a minimum hold period, there have been situations in which the IRS did not permit an exchange because the owner’s intent was unclear.

Investors uncertain about whether they qualify may generally want to adhere to the two-year recommendation. However, as always, speak to your tax professional to get their professional advice about your particular situation. 

The two-year holding period was mentioned by the IRS in 1984 in Private Letter Ruling 8429039. The letter was written in response to an investor who wanted to trade his property via an exchange. The property in discussion was used as the investor’s primary residence until 1981. In 1983, the investor rented the property out. When pursuing a 1031 exchange in 1984, the investor requested a 1031 exchange; the IRS approved, stating that holding rental property for a minimum of 2 years is sufficient to meet the holding period test prescribed by Section 1031. However, a private letter ruling only applies to this particular case and is therefore only considered to be a general guideline for 1031 exchanges.

The one-year holding consideration, on the other hand, was introduced in 1989 when congress proposed a 1-year holding period for a property to qualify for a 1031 exchange. However, this proposal was never integrated into the Tax Code and is therefore not a requirement. Instead, tax advisors have referenced this proposal when determining if a property could qualify under Section 1031.

Another consideration for the one-year holding period is that by holding the property for at least 12 months, the investment will be reflected as an investment property on one’s taxes for two filing years.

These considerations, however, are just that – considerations. Historically, the IRS has made decisions regarding like-kind exchanges that do not align with these proposals. For example, in 1953, in the case Allegheny County Auto Mart v. C.I.R., the court permitted an investor to complete a 1031 exchange after holding property for only five days, whereas in other cases, such as one in 1967 in Klarkowski v. Commissioner, an investor was disqualified even after a six-year holding period.

Does a vacation home qualify?

While most commonly 1031 exchanges are discussed amongst commercial investors, those holding property as a vacation home can typically sell it and purchase a new property via a 1031 exchange. However, the vacation home must have tenants, and the property must be treated in a business-like manner. Furthermore, if the vacation home is acquired as the replacement property, the property must continue to be used for investment purposes. Generally, the home cannot be converted to a primary residence within five years following the exchange.

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Other Important Timelines in a 1031 Exchange

To qualify for a like-kind exchange, investors must understand and adhere to the timelines outlined in Section 1031.

Once a property is listed, there is no guideline on how long an investor has to sell the asset. They can sell it on or off-market and market it for one day or five years. In fact, they can list the asset and then change their mind. Up until the property is sold, any gains are unrealized. It is not until the property actually closes that a timeline kicks off, and the investor could be responsible for paying taxes on the realized gains.

When the initial property – or relinquished property – closes, an investor has 45 days to identify their replacement property and 180 days to close. The 180 days also commence from the closing date of the relinquished property. With few exceptions, any exchange that does not meet these deadlines results in all gains being taxable.

Speak to a Qualified Professional

Many 1031 exchanges look different, and for those considering selling their real estate and purchasing a new property via a 1031 exchange, speaking with a qualified professional is highly recommended. Not only can they offer insight on the possible exchange, but 1031 experts can also introduce investors to alternative 1031 exchange investment solutions that may otherwise be overlooked.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure: