Many investors in today’s market are aware of the long-term benefits of selling and buying an investment property. One downside to this method is the amount of capital gains tax investors must pay on their sales. That’s why many investors use a property exchange process that helps reduce this tax burden.
If you’re a first-time property investor, then you should find out more about this process called 1031 exchanges. This process has built-in benefits that will reduce your tax burden on any profits from your sale.
Check out this guide and you’ll learn more about these exchanges. Find out how real estate professionals can help lead you through the process.
What is a 1031 Exchange?
A 1031 tax exchange is when investors sell their property and “swap” the profits from that sale to buy another new investment property. The advantage to this “swap” is that the original seller won’t have to pay capital gains taxes on any profits they received from their sale.
They won’t have to pay the taxes because the money never reaches their bank account. The profits go straight towards buying the second property.
Property buyers and sellers must complete their transactions within 180 days of the first sale to avoid any tax consequences. The sold property should be of equal or higher value to the purchased property. Buyers and sellers can not exchange any cash and there shouldn’t be any debt relief to avoid extra taxes.
These transactions are named after Section 1031 of the US Internal Revenue Code. 1031 exchanges apply to only commercial property or vacant land. 1031 rules forbid these exchanges on a person’s private home.
1031 Tax Exchange Companies
A 1031 tax exchange company can facilitate sales between sellers and buyers. These companies will buy your new property and sell your old property on your behalf. They also hold your sales proceeds and then apply them to your replacement property purchase.
Section 1031 rules prohibit these companies from having formal relationships with these buyers or sellers. exchanging properties. Siblings or parents are not allowed to represent anyone in these transactions.
Section 1031 also prohibits any broker or attorney to be your agent if they have represented you on other matters two years previous.
A 1031 tax exchange company is a critical intermediary to completing of a 1031 exchange. These companies help both buyers and sellers keep their distance from each other while they oversee the property swap.
1031 Tax Exchange Company Services
Some of the duties that a 1031 tax exchange company can provide include the following:
- Coordinates with the buyer and seller on the format for the 1031 exchange;
- Prepares necessary documents relating to the replacement property as well as the sold property;
- Presents these documents and specific instructions to the escrow or title companies;
- Drafts an arms-length affidavit between property buyers and sellers. This affidavit certifies that there are no pre-existing relationships between either the buyer and the seller. These affidavits can also show there are no pre-existing relationships between the property owner and the 1031 exchange company;
- Transfers conveyance of the sold property on behalf of the seller to the new property owner;
- Manages the proceeds from the sale of the surrendered property and deposits them into an insured and separate account;Keeps the sales proceeds from the sold property during a 45-day escrow identification period;
- Collects and stores sales information about potential, like-properties for the buying client;
- Transfers the stored funds to buy the new property. Distributes these funds to the escrow or title company. to complete the sale;
- Receives the property deed or title of the replacement property from the seller;
- Drafts a full accounting report on the 1031 exchange for both the buyer and the seller. 1031 tax exchange rules have specific parameters that should be addressed in this accounting report; and
- Submits a 1099 form to report any income sellers received throughout the year from sources other than their salary. These forms also report any interest earned or paid growth proceeds as well. 1031 exchange intermediaries also prepare all necessary legal documentation to comply with IRS guidelines for like-kind property sales.
Qualifications to Look for in a 1031 Exchange Company
There are certain qualities you should make note of when choosing a 1031 exchange company to represent you. These companies should be prepared to share the pros and cons of real estate investing with you. Look for a transparent company willing to share their perspectives.
Top companies that offer 1031 exchange services are nationwide. It’s important that these companies offer consistent service throughout each branch office. Federal law governs these exchanges, so performance should be uniform throughout every location.
You can also decide to go to a local office to help you. Be sure to find professionals who can take the headaches out of the 1031 exchange process. This company, for example, specializes in making the process easy, and providing clients a healthy selection of pre-qualified properties,
Exchange companies should also be insured and bonded. The best companies will be those that also have a strong financial standing. 1031 companies should also show their industry experience with organizing exchanges consistent with federal laws.
Next Steps
Before you interview a potential company to represent you, do some homework first. Research 1031 tax exchange rules to familiarize yourself with the requirements. Ask your friends and family members for referrals.
When you do meet with an exchange company representative, ask them to show you their errors and omissions insurance. Request that they show you a proof of their fidelity insurance. That way you’ll know if your investments are protected against fraud or negligence.
You can also ask local escrow officers for their recommendations. They might have suggestions on which company will represent you the best.
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