A 1031 exchange allows an investor to avoid paying capital gains taxes when selling an investment property by reinvesting the proceeds from the sale to another investment property. There are 7 general principles outlined below to qualify for this type of transaction.
- 1st Requirement: Property gained must be of “Like-Kind” to the property sold in nature or characteristic. For example, if you sell an apartment building, you have to “replace” that investment with another type of investment property like farm land, a commercial building, vacant land or industrial property. You could not replace it with an investment in artwork; it would not qualify as “Like-Kind”.
- 2nd Requirement: An investor has a 45-day period to locate and designate the replacement property, or properties.
- 3rd Requirement: An investor then has 180 days after the original sale to complete the purchase transaction of that replacement property.
- 4th Requirement: Use of a qualified intermediary. This is a person or company used to facilitate the exchange by holding the funds used in the transaction during the 180 day purchase period.
- 5th Requirement: Mirror image on title must apply. If John Smith was the sole owner of a property, he could not then use a 1031 exchange to purchase the new property with a partner. Ownership of property being sold must match ownership of property being acquired.
- 6th Requirement: The new property must be of equal or greater value in order to defer the full capital gains tax, and all cash profits must be reinvested.
- 7th Requirement, Reverse Exchange: A reverse exchange is used when the investor has found a new property he/she wants to acquire (and does not want to let it slip away), but has yet to find a buyer for the original property. The IRS guidelines for this type of transaction state you may purchase the new property (cash transaction preferred) and the title will be held by a “qualified parking arrangement” until the old property is sold within the 180 days.
To summarize the 7 rules above, there are countless scenarios in which a 1031 exchange can be utilized, and every one of them unique. If you understand the 7 principles above, you have an understanding of 95% of the Section 1031 of the Internal Revenue Code.
1031 Examples on the Central Coast
Vineyards are a great asset to add to your investment portfolio. Using a 1031 exchange for acquisition keeps more of your cash in your investment pocket.
- 10 years ago you purchased a series of 6 duplex buildings for $1.5 million that are now worth $2.4 million and you are looking to get out of the rental business. You could divest those assets, take the $2.4 million, with no capital gains tax, and purchase a revenue generating vineyard on the central coast, California’s up and coming premier wine industry.
- A farmer in the central valley may own hundreds of acres spread out over a large area. It is time to retire and consolidate holdings. He could sell those various parcels of land, take that combined profit, and purchase a lifestyle vineyard on the central coast near the beach for grandkids to vacation at. An added perk in this example is that a luxury vineyard can produce anywhere from 2-8 tons per acre of grapes with prices ranging from $1,000-$5,000 per ton.
- A colleague, Karen Wells, has been utilizing 1031 exchanges in a unique way for the last 15 years. Her clients sell an investment, let's say ranch land for example, and she assists them in purchasing office space using a 1031 exchange that is leased to government entities. The up side in this system is gaining a long-term, consistent tenant earning you passive income.
Qualified Intermediaries for the Central Coast
As referenced in the 4th requirement, it is vital to use a qualified intermediary to carry out your transaction. The central coast has access to many companies to fill this requirement for you, a few recommendations are below:
- Jamie Furlong at Legacy Investment Real Estate- https://www.legacyire.com
- IPX 1031, Fidelity National, Northern California- https://www.ipx1031.com
- First American Exchange Company- https://firstexchange.com
Go to www.JennyHeinzen.com to see current properties for sale, this could be your future through a 1031 Exchange!
If you have questions, or have facts or circumstances which you are uncertain of, I would greatly encourage you to consult a CPA or an attorney who has experience and is knowledgeable with 1031 tax deferred exchanges.
Other great links for reference: