1031 Exchanges and Your Taxable Wealth
The 1031 exchange has been around for quite some time, and people often refer to it not knowing that there is an actual section of the tax code that defines how the 1031 exchanges should operate. As a real estate investor, this can be one of the biggest advantages to your wealth creation, and oftentimes it can be done incorrectly which can lead to costly penalties and taxes.
Tax Deferred vs. Tax Free
There is a common misconception that if you are participating in a 1031 exchange there will be tax free wealth that is earned. Although it is possible to earn tax free wealth through using a 1031 exchange, there would need to be much more financial planning involved than just the 1031 exchange by itself.
Most commonly a 1031 exchange is a tax deferred exchange. This means that you can say goodbye to those pesky tax payments for this go around, but your tax is only being deferred until you stop exchanging your properties. Once you have stopped exchanging your properties your tax will now be due, and there are still many different ways to get around this, but I would recommend to speak to your tax professional about that, along with any other legal professionals, etc. that might be on your advisory board.
Exchange Resources are Useful
I had a Client once who was purchasing a multifamily investment property here in Bakersfield. We were going to sell his property and he was going to purchase another property. The only problem was that he didn’t tell me he wanted to purchase another property until after the first property closed. Then he tells me he wants to use a 1031 exchange to defer the taxes, but by this point the funds for his transaction had already hit his account, and now he was going to be liable for a six figure gain on his property.
All of this could have been avoided if he had just gone to his resources originally. If he had spoken to me, his Broker/Agent, about wanting to do a 1031 exchange we could have pointed him in the direction of multiple information sources. On top of this, his 1031 intermediary could have been of much help in having him avoid that tax penalty, but this is a normal mistake that is made with newer real estate investors. Always know ahead of time how you want to enter your deal, and especially when doing a 1031 exchange because once the funds hit your account there is no backing up and retracing your steps.
Due Dates Are Important
When dealing with a 1031 exchange, a lot of people get worried about the different dates that are involved, and a lot of time a good 1031 exchange intermediary is someone that can easily help you navigate through these timelines. For example, when looking to purchase a property, the initial properties must be identified within 45 days from the close of escrow on the previous property.
From there, you can identify up to 3 separate properties that will fit your criteria and you can go after. You can choose to purchase all 3 or just 1 depending on the amount of the exchange. Finally, you will have to close the property within 180 days of the previous escrow closing. This should allow you to set up the transaction as needed with the proper intermediaries and parties to the transaction. If any of these deadlines are missed, it could mean a large tax implication for you as an investor.
In the end, I would recommend to hire professionals who can help with what you are trying to do and have experience with what you are trying to accomplish. Especially in the arena of exchanges because there are major financial consequences from not adhering to a simple stipulation of the process.
Until next time,
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Synergy Real Estate & Property Management
Sanjeev (Sunny) Advani
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