Section 1031 of the Internal Revenue Code (IRC) underlines the rules for exchanging property that is held for investment or productive use. If one meets the requirements, he/she can acquire real estate through 1031 exchange or like-kind exchange.
The strategy involves selling a property to obtain a like-kind property. In a 1031 exchange, one can defer the taxes on the sale of property , or you can pay a restricted amount.
There are few 1031 exchange approaches available, depending on your objective and circumstance. Let’s have a look at the types that are available to the United States taxpayers.
Simultaneous 1031 Exchange
A simultaneous exchange happens when you sale the property and acquire the replacement property at the same time. The exchange has to happen simultaneously, and a small postponement can lead to the exclusion of the 1031 benefits.
Simultaneous exchanges sometimes raise logistical issues making it difficult to achieve them. A common problem arises when the properties are being swapped are between different areas.
The exchanging parties can choose to swap deeds or invite an accommodating party to facilitate the exchange. Else, they can hire a professional intermediary to structure everything on their behalf.
Delayed 1031 Exchange
This 1031 real estate exchange is the most widely recognized program. The investor relinquishes his or her property before investing in the replacement property. In other words, you first exchange the property you want to give up before securing the desired replacement.
To start a delayed exchange, you need to showcase your property, find a buyer, and execute the sale and buy the agreement. Next, you have to hire an independent exchange intermediary to oversee the sale of the relinquished property. The third-party holds the proceeds for a maximum of 180 days to acquire a like-kind property.
Delayed exchange became popular because of the reason that it gives the investor ample time for the completion of transaction.
Reverse 1031 Exchange
A reverse 1031 exchange is that exchange where the replacement property is bought first and ends with selling the relinquished property. The investor procures the real estate via an exchange accommodation title holder.
The taxpayer has to declare the real estate to offer as relinquished property within 45 days. After this period, the exchanger has 135 days to complete the sale and close the exchange.
Also termed as a construction exchange, improvement exchanges allows investors to upgrade the replacement property with the exchange equity. That is, the taxpayer can spend the deferred tax amount on improving the replacement property before closing the 1031 exchange.
This type of exchange is suitable for people who want to acquire a replacement property that doesn’t match their needs. This real estate exchange allows you to make the necessary improvements on the real estate and include the construction as part of the exchange.