What is a 1031 Exchange?

You may hear the term 1031 exchange when discussing real estate transactions without fully understanding what the term means.

It is a process established to help an investor defer taxes on gains he may realize on investment property.


Exchange

This term is a bit misleading. The process actually involves the coordinated sale and purchase of 2 or more properties. There is a third-party facilitator involved who may hold the proceeds from the sale escrow until they are called for by the purchase escrow holder. This is done to assure that the investor never takes possession of the proceeds from the sale.

Deferred Taxes

Taxes are deferred, not avoided. The investor’s basis in the original property is carried through to the new property. No tax is paid on the gain until the newly acquired property, or its 1031 successor is sold,

Investment Property

Investment property is defined as property owned other than the primary residence of the owner. It can be a second home, vacant land, or income producing property.

Timing

 A 1031 exchange requires the investor to declare before close of escrow, his intention to enter into a 1031 exchange. He then has 45 days from Close of Escrow to identify the replacement property. And 180 days to close on the property.

Value

The value being exchanged is not the sale price of the property, but the owner’s equity. In essence, the owner must maintain the same equity and take on as much or more debt in the new property as he has in the existing property.

Reality

 The reality is that it is very difficult to find a trade up property to exchange into at the time you need it, at the value you need or can afford, and in your geographic area.

Commentary 

One of the beauties of the Triple Net income property is that it is structured in such a way that there are no day to day management responsibilities requiring the owner’s attention, Therefore it is not necessary that the property be in close geographic proximity to the owner.

Triple Net properties also come in many variations and values, so that at any given time, a prospective purchaser should be able to find properties that suit his value, income and risk parameters. This allows him some choice in selecting the best move up property for his personal situation

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