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If you’re a realtor or homeowner preparing to sell their property, you may have come across the term “1031 exchange.” 1031 exchanges are a powerful tool that can help investors and homeowners defer paying capital gains taxes on the sale of their property. However, many people are too intimidated to take advantage of this opportunity because they don’t understand the process.
This article will start by explaining the basics of 1031 exchanges and then move on to the five key facts that realtors should know about completing a real estate transaction with a 1031 exchange.
What is a 1031 exchange?
A 1031 exchange, also known as a like-kind exchange or Starker Exchange, is a tax-deferred exchange of property held for investment or business purposes. The 1031 Exchange allows an investor to sell one property and purchase another without paying any capital gains taxes on the sale.
This type of exchange is attractive to investors because it allows them to reinvest their money without having to pay any taxes on the sale of their property.
The 1031 exchange was created by Section 1031 of the Internal Revenue Code and is one of the most powerful tax deferral strategies available to investors.
To complete a 1031 exchange, you must follow these three steps:
1. Sell your investment property.
2. Use a qualified intermediary (QI) to hold the proceeds from the sale.
3. Purchase a new investment property within 180 days of selling your original property.
The QI is a critical part of the 1031 exchange process because they act as a neutral third party that holds onto the proceeds from the sale of your property. The QI must be a licensed and bonded company that is not affiliated with you or the buyer.
Once you have sold your property, you have 180 days to find a replacement property and complete the exchange.
The replacement property must be of “like-kind,” which means it must be used for investment or business purposes. You can exchange one type of property for another, such as exchanging a commercial building for an apartment complex.
The replacement property must also be equal to or greater in value than the property that was sold. If the replacement property is of lesser value, then the investor will owe capital gains taxes on the difference in value.
5 Key Facts Realtors Should Know About 1031 Exchange
1. A 1031 exchange is a powerful tool that can help investors and homeowners defer paying capital gains taxes on the sale of their property.
2. To complete a 1031 exchange, you must follow these three steps: sell your investment property, use a qualified intermediary (QI) to hold the proceeds from the sale, and purchase a new investment property within 180 days of selling your original property.
3. The replacement property must be of “like-kind,” which means it must be used for investment or business purposes. You can exchange one type of property for another, such as exchanging a commercial building for an apartment complex.
4. The replacement property must also be equal to or greater in value than the property that was sold. If the replacement property is of lesser value, then the investor will owe capital gains taxes on the difference in value.
5. 1031 exchanges are a complex process, so it’s important to seek professional guidance from a qualified tax advisor or real estate attorney before proceeding with an exchange.
Remember to Consider Commission Potential
While 1031 exchanges can be a great way to defer capital gains taxes, it’s important to remember that realtors may not receive commissions on these types of transactions.
In order for a realtor to receive a commission on the sale of a property, the property must be sold on the open market to an unrelated third party.
1031 exchanges are typically between two related parties and are not considered “arm’s length” transactions. As such, realtors cannot collect commissions on the sale of properties that are exchanged in a 1031 exchange.
However, realtors may have other opportunities to earn income on 1031 exchanges. For example, a realtor could represent the buyer of the replacement property in the exchange.
Additionally, some real estate brokerages offer referral fees for 1031 exchange transactions. These referral fees are typically a percentage of the exchange’s total value and can be a great way for realtors to earn income on these types of deals.
How a Professional Can Help
While 1031 exchanges can be a great way to defer capital gains taxes, they are also a complex process. There are many rules and regulations that must be followed in order for the exchange to be valid.
Additionally, 1031 exchanges require the use of a qualified intermediary (QI), which is a licensed and bonded company that is not affiliated with you or the buyer.
For these reasons, it’s important to seek professional guidance from a qualified tax advisor or real estate attorney before proceeding with an exchange.
A professional can help you navigate the complex rules and regulations surrounding 1031 exchanges and ensure that the exchange is conducted properly. Additionally, a professional can help you find a reputable QI to work with on your exchange.
Reach out to our team of qualified 1031 exchange experts today to learn more about how we can help you defer capital gains taxes on your next real estate transaction!