Since you’re looking for 1031 exchange rules 2020, we assume you to be familiar with this tax-deferred exchange. In case you have some doubts, Section 1031 of IRC lets investors defer capital gains taxes on exchanging like-kind properties. When we say like-kind, we mean properties that are similar in nature. So, if you own income-producing property, then it can only be exchanged for another income-producing asset under 1031 exchanges. Though investors may assume 1031 exchanges to be easy, however, it isn’t so. 1031 exchanges are quite complex, and you definitely require the assistance of a financial expert. What basically makes 1031 exchanges complex is its rules, or you can say requirements.
1031 Exchange property types –
First, let’s look at property types that can be swapped using 1031 exchanges. Undoubtedly, you are not allowed to exchange ‘any’ property and defer taxes using this unique investment options. The rules established by the IRS require subject properties to be income-producing assets. Therefore, you can only swap two investment properties with one another. But, you can certainly change the way in which the property is used. For example, using a 1031 Exchange, you can exchange a multi-family apartment for an industrial property or a student housing building and vice-versa.
1031 Exchange Rules 2020:
- The first requirement is that an investor must involve a Qualified Intermediary in a 1031 exchange. Generally, an investor enters a 1031 exchange along with a Qualified Intermediary. A Qualified Intermediary or a facilitator is responsible for executing 1031 exchanges on behalf of investors. So, it’s a Qualified Intermediary who plays the lead role in a 1031 exchange, and not investors.
- The second rule requires an investor to identify the potential replacement property within 45 days from the sale of the old property (Identification Period). It’s mandatory that a written identification of the replacement property, containing the street address, reaches 1031 Corporations on or before the 45th day.
- Once the identification period ends, an investor is required to acquire the identified replacement property within 135 days. In other words, an investor gets 180 days in total for completing a 1031 exchange. The first 45 days are given for the identification of the replacement property, which must be acquired in the next 135 days.
- Only like-kind properties can be exchanged under 1031 exchanges. This is the most important requirement of 1031 exchanges. An investor is only allowed to exchange their property for another like-kind property. For example, a retail shop can only be exchanged for another retail shop.
- Properties involved in 1031 exchanges must be held for use in trade or business or for investment purposes. This means that personal properties can’t be exchanged under 1031 exchanges.
- An investor can’t touch the proceeds of their relinquished property. It’s the Qualified Intermediary, who holds the proceeds of the relinquished property and reinvests it on the replacement property.
A 1031 exchange will immediately disqualify in case of violation of any of the above-mentioned rules. However, it’s worth mentioning that a few of these rules may also change depending upon the type of 1031 exchange you’re a part of. For example, there is no identification period in a reverse 1031 exchange.
Different types of 1031 exchanges:
- Simultaneous Exchange – A simultaneous exchange requires investors to sell their relinquished properties and acquire replacement properties at the same time. Therefore, in a simultaneous exchange, there is no identification period, and you don’t get extra time for acquiring the replacement property.
- Delayed Exchange – A delayed exchange is the most common form of 1031 exchange. Here, upon closing on the sale of the relinquished property, investors get 180 days for completing the entire exchange, where the first 45 days are given to identify the potential replacement property.
- Improved or Built-To-Suit Exchange – In this kind of 1031 exchange, investors can invest a portion of the proceeds on the improvement of the replacement property. A built-to-suit exchange normally takes place when the cost of the replacement property is less than that of the relinquished property.
- Reverse Exchange – A reverse exchange is the opposite of a delayed exchange. In a reverse exchange, the replacement property is acquired first before closing on the sale of the relinquished property.
As you can see, every 1031 exchange has a different procedure. Therefore, rules associated with different 1031 exchanges may vary. In order to minimize financial risks, it’s important that you consult a financial advisor before initiating a 1031 exchange.
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