1031 Exchange Basics
The Internal Revenue Code 1031 exchange, also known as a Starker exchange, is a tool investment second-home owners can use to sell their existing real estate and purchase new property with all capital gains taxes deferred as long a certain criteria are met.
A 1031 exchange is considered a “like kind” exchange of property. This exchange can be tricky and should be conducted through the services of a Qualified Intermediary, also referred to as an Exchange Accommodator. Your Real Living Sales Professional can help you find one.
The Qualified Intermediary is an independent party who helps accommodate both the sale and subsequent purchase transactions.
Before pursuing a 1031 exchange remember: This option is only available for investment property. If you’re not sure if your second home is considered investment real estate, check where it falls in the four tax categories for second homes. If you use your second home for no more than 14 days in a year, or 10 percent of the days rented if that number is greater, the IRS will consider your second home investment real estate.
The Clock is Ticking
Once you begin the 1031 exchange process you have 180 calendar days dating from the closing of the sale of your investment second home to complete the exchange process into your new investment real estate.
After closing on your sale the first deadline hits at 45 days. By this date, through your Qualified Intermediary, you must designate your candidate property, or properties, and identify them to the IRS.
The penalty for missing either deadline is the funds in the trust held by your QI from the sale of your investment second home will be liquidated and the proceeds are taxed on capital gains and depreciation recapture. This tax hit can be substantial so it’s important to get into a 1031 exchange carefully to ensure every step is completed correctly and on time.
The reward for a successful 1031 exchange is you can use the proceeds from the sale of investment second home to purchase another piece of investment real estate – within 180 days of the sale, of course.
The real benefit is: If the price of the replacement property is equal to or greater than the sale price of your relinquished real estate, no tax is immediately due. That tax is deferred, plus the tax basis of your relinquished real estate becomes the tax basis for the replacement property.
