A 1031 exchange is a tax strategy based on Section 1031 of the Internal Revenue Code. It allows taxpayers to defer capital gains taxes by selling an investment property and reinvesting the proceeds into another asset. The exchange has strict rules regarding timelines but offers flexibility in terms of eligible properties.
A 1031 exchange is a tax strategy that allows investors to defer the payment of capital gains taxes when they sell an investment property and reinvest the proceeds in "like-kind" property. The concept of a 1031 exchange derives its name from Section 1031 of the Internal Revenue Code. By following the rules and guidelines established by the IRS, investors can take advantage of this tactic to potentially save significant amounts of money on taxes.
One of the key aspects of a 1031 exchange is the definition of "like-kind" property. The IRS broadly interprets this term, allowing for exchanges between different types of commercial properties. For example, an investor could sell a multifamily housing complex and reinvest in self-storage facilities, or sell raw land and purchase an office building. However, it's important to note that a primary residence cannot be exchanged for an investment asset under the provisions of a 1031 exchange.
To successfully execute a 1031 exchange, investors must comply with several important requirements. One key requirement is adhering to a strict timeline. After selling the original property (referred to as the relinquished asset), investors have 45 days to formally identify potential replacement properties.
Formal identification involves notifying a Qualified Intermediary, who oversees the transaction and manages a separate account for the proceeds. The identified replacement properties must fall under one of the following options:
Three-property rule: Investors can identify up to three potential replacement properties without any limit on their combined value. They have the flexibility to purchase any one property or a combination of the identified options.
200% rule: Investors can identify an unlimited number of potential replacement properties as long as the combined value does not exceed 200% of the sale price of the relinquished asset. This rule is beneficial for investors looking to downsize their holdings by acquiring smaller value properties.
95% rule: Investors can identify any number of properties, but they must acquire a combination of properties that equals at least 95% of the combined value. This rule is less commonly used and may decrease the chances of a successful exchange.
Adhering to these requirements is crucial for investors seeking to take advantage of the tax benefits offered by a 1031 exchange.
After the identification process, the investor must complete their transaction within a total period of 180 days, including the initial 45-day identification period, in order to defer the payment of taxes. The Qualified Intermediary, responsible for overseeing the exchange, maintains transaction documentation and transfers funds from the separate escrow account to the sellers. Importantly, the taxpayer must not have access to the funds during the exchange process.
While a 1031 exchange defers capital gains taxes rather than eliminating them, this strategy can be used repeatedly. For instance, if an investor performs a 1031 exchange and later sells a property without utilizing the exchange, they will owe the deferred taxes. However, they can continue to employ the exchange method to swap properties in subsequent transactions. When the investor ultimately passes the last property to an heir, the heir receives it at the stepped-up value, effectively eliminating previous deferred tax obligations.
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
Perch Financial LLC and Emerson Equity LLC do not provide legal or tax advice. Securities offered through Emerson Equity LLC Member FINRA/SIPC and MSRB registered. Emerson Equity LLC is unaffiliated with any entity herein. 1031 Risk Disclosure:
No offer to buy or sell securities is being made. Such offers may only be made to qualified accredited investors via private placement memorandum. Risks detailed in a private placement memorandum should be carefully reviewed, understood, and considered before making such an investment. Prospective strategies and products used in any tax advantaged investment planning should be reviewed independently with your tax and legal advisors. Changes to the tax code and other regulatory revisions could have a negative impact upon strategies developed and recommendations made. Past performance and/or forward-looking statements are never an assurance of future results.
Many of the investments offered will be only available to those investors meeting the definition of an Accredited Investor under SEC Rule 501(A) and offered as Regulation D private placement securities via a Private Placement Memorandum (“PPM”). Prospective investors must receive, read, and understand all the risks associated with buying private placement securities. Investments are not guaranteed or FDIC insured and risks may include but are not limited to illiquidity, no guarantee of income or guarantee that all tax advantages or objectives will be met and complete loss of principal investment could occur.
Risk Disclosure: Alternative investment products, including real estate investments, notes & debentures, hedge funds and private equity, involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor's interest in alternative investments, and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-U.S. exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in U.S. markets. Additionally, alternative investments often entail commodity trading, which involves substantial risk of loss.
NO OFFER OR SOLICITATION: The contents of this website: (i) do not constitute an offer of securities or a solicitation of an offer to buy of securities, and (ii) may not be relied upon in making an investment decision related to any investment offering by Perch Financial LLC, Emerson Equity LLC, or any affiliate, or partner thereof. Perch Financial LLC does not warrant the accuracy or completeness of the information contained herein.
