Exchange and partial exchange are two ways of deferring taxes when you sell or buy real estate properties. In this article, you will learn what they are, how they work, and what benefits and challenges they offer.
An exchange is a transaction where you swap one property for another of equal or greater value, without paying any capital gains tax. This is based on Section 1031 of the Internal Revenue Code, which allows you to defer taxes on the gain from the sale of a property if you reinvest it in a similar or like-kind property within a certain time frame. An exchange can be either simultaneous or delayed, depending on when you transfer and receive the properties.
A partial exchange is a variation of an exchange where you swap only a portion of your property for another property, and receive some cash or other non-like-kind property as well. For example, you might exchange a 50% interest in a rental property for a 100% interest in another rental property, and receive some cash in the process. A partial exchange is also subject to Section 1031 rules, but you will have to pay taxes on the cash or non-like-kind property you receive, also known as boot.
The main benefit of an exchange or a partial exchange is that you can defer taxes on the gain from the sale of your property, and use that money to invest in another property that suits your needs better. This can help you diversify your portfolio, increase your cash flow, or consolidate your assets. Another benefit is that you can avoid or reduce depreciation recapture, which is the tax you pay when you sell a property that has depreciated in value over time.
The main challenge of an exchange or a partial exchange is that you have to comply with the strict rules and deadlines of Section 1031. For example, you have to identify the replacement property within 45 days of the sale of the relinquished property, and close the transaction within 180 days. You also have to ensure that the properties are of like-kind, meaning that they are used for investment or business purposes, and not for personal use. Another challenge is that you have to find a qualified intermediary, who is a third-party that facilitates the exchange and holds the funds until the transaction is completed.
There are different ways to structure a partial exchange, depending on your situation and goals. One way is to use a partnership or a limited liability company (LLC) to own the property that you want to exchange, and then sell or buy a partial interest in the entity. Another way is to use a tenant-in-common (TIC) arrangement, where you own a fractional interest in the property along with other co-owners, and then exchange your share for another property. A third way is to use a reverse exchange, where you acquire the replacement property before you sell the relinquished property, and use a qualified intermediary to hold the title until the exchange is completed.
If you are considering an exchange or a partial exchange, it is important to plan ahead and consult with a tax advisor, a real estate agent, and a qualified intermediary. Research a suitable replacement property that meets your criteria and the Section 1031 rules. Additionally, keep track of the deadlines and the paperwork, and follow the instructions of the qualified intermediary. Be flexible and prepared for unexpected issues or delays that might arise during the transaction. Lastly, review the closing statements and the tax forms carefully, and report the exchange or the partial exchange correctly on your tax return.
some of the things that have helped me is having a strong team who can help and assist when we have issues or prevent any of them.
Look at the laws in your state. keep in mind some of them might have tax issues. if you have an llc from out of state research what are the issues with that in the state where the llc is made and where you invest ... best to ask a lawyer they can help you with this 1031 exchange