One thing that bothers most real estate investors is the taxes they need to pay when they sell or purchase any property. Capital gains taxes could be enormous in bigger deals and may take away millions from your pocket. To avoid capital gains taxes, you can make use of Section 1031 or what we normally call a 1031 exchange. A 1031 exchange lets you exchange an investment property for another like-kind property without any tax consequences. Technically, when you sell an investment property and reinvest the entire proceeds in another investment property, you can defer up to 100% capital gains taxes.
To qualify for a 1031 exchange, you are required to fulfill the following guidelines-
- Only investment or income-producing assets qualify for 1031 exchanges. Personal properties (primary residence or a vacation home) are barred from 1031 exchanges.
- Both relinquished, and replacement properties must be like-kind.
- The value of your new property must be equal to or greater than the value of the property you sold.
- Both properties should have the same debt.
- You must hire a Qualified Intermediary for your 1031 exchange.
- You get 180 days in total, known as the exchange period, to close an exchange.
How does property identification work in 1031 exchanges?
A typical 1031 exchange, known as a forward or delayed exchange, requires an investor to sell their relinquished property first and then acquire the replacement property. After you sell your old property, you must identify a potential replacement property within 45 days – it’s called the Identification Period. Written identification of one or more replacement properties must reach to the IRS on or before the midnight of the 45th day.
Look for less management-intensive replacement options.
1031 investors often look for easy to close and less expensive buying options when it comes to acquiring the replacement property. As most 1031 properties are large institutional-grade buildings, investors with a stiff budget may face difficulties in locating replacement properties for their 1031 exchange. However, if planned properly, finding an ideal replacement property under a given budget may not be an issue.
One thing you would not want to happen after your investment is – losing your monthly income in paying operating expenses. One of the best ways to ensure you are not loaded with landlord responsibilities is to invest in triple net properties. A triple net or NNN lease is a single-tenant arrangement where the tenant pays all operating expenses associated with the property they’ve rented. Different from a gross lease where the tenant only pays a flat rent, a NNN lease asks them to pay property tax, insurance fee, and maintenance cost along with the base rent. 1031 investors often make use of NNN investment to close their exchange. That’s why the demand for 1031 exchange triple net properties has skyrocketed in recent years.
Does your old property also need to be a NNN property to qualify for a 1031 exchange?
Not really. Section 1031 just requires the relinquished and replacement properties to be like-kind. Both properties may serve different purposes. For example, you can exchange a multi-family apartment for a retail shop or vice-versa using a 1031 exchange. However, personal properties are exempted. Only income-producing properties can be exchanged using a 1031 exchange. Therefore, your relinquished property doesn’t need to be a NNN property to 1031 exchange it into one or more triple net properties.
How can you invest your 1031 proceeds in triple net properties?
Once you close on the sale of your relinquished property, you must enter a 1031 exchange along with a Qualified Intermediary. In the next step, you must identify one or more potential replacement properties within 45 days, which begins the day you close on the sale of your relinquished property. Submit the written identification of the replacement property to the IRS on or before midnight of the 45th day. On the closing day, which could be the 180th day or earlier from the day of sale of the relinquished property, you must deposit the proceeds and acquire the identified net leased property.
You can find exclusive net leased properties in the property section of our website. Get high credit-rated tenants like McDonald’s, KFC, CVS, and more.