A 1031 Exchange allows an investor to swap one property for another in order to defer capital gains taxes. This can allow an investor to build significant wealth by reinvesting the funds that would otherwise be taxed.
The term '1031 Exchange' gets its name from Section 1031 of the Internal Revenue Code (IRC). This code requires that investors follow a certain set of guidelines for their exchange to be free from capital gains taxes.
The following is everything you need to know about 1031 Exchanges in Winston-Salem.
What is a 1031 Exchange in North Carolina?
Broadly speaking, a 1031 Exchange is an exchange of one investment property for another.
Normally, most real estate sales are subject to capital gains taxes. However, if you instead carry out an exchange that abides by the requirements in Section 1031 of the IRC, then you’ll have be able to defer these taxes.
Practically speaking, it’s entirely possible to continually exchange your investment property to another one as many times as you want, and defer them indefinitely. That's because there is no limit to how many swaps you can make.
While a 1031 Exchange doesn’t mean you’ll never pay capital gains taxes, you may be able to avoid doing it until you ultimately sell your property for cash many years later.
What Are the Requirements for a Successful 1031 Exchange in NC?
The following are the requirements that Section 1031 of the IRC requires:
The properties being swapped must be like-kind.
To qualify, the properties you’re looking to swap must be like-kind. ‘Like-kind’ is a bit misleading of a name; it may not mean exactly what you think. The two properties don't have to be the same size or type of property.
It’s possible, for example, to exchange a multifamily property for an industrial, or a strip mall for an apartment building, a condo building for a single-family rental home, and so on.
However, the properties being exchanged cannot be your primary residence.
The properties must be for investment or business use.
The 1031 provision only applies to properties that are held for investment or business use. In other words, the exchange is reserved for trade, business, or investment properties.
A single-family residence, a commercial building, a vacant lot, or an apartment building would therefore qualify.
Your primary residence, on the other hand, wouldn’t qualify.
Certain timelines must be respected.
Theoretically, a 1031 Exchange is meant to be a simple exchange of one like-kind property for another. That being said, the chances of finding someone with a similar property as yours are quite slim.
For this reason, the majority of the exchanges that occur are delayed.
In a delayed 1031 Exchange, you’ll need to be punctual for a successful swap. In addition, you’ll need to seek professional help from a Qualified Intermediary.
This will be the middleman who will co-ordinate the entire exchange on your behalf.
This is the first timeline under a Delayed 1031 Exchange. Once you’ve sold your property, the qualified intermediary will receive the money on your behalf. Please note that you cannot handle the cash yourself, unless the 1031 Exchange fails.
Also, you must designate the replacement property to the intermediary within this timeline. You must do so in writing, and specify the exact property you wish to exchange it for.
According to the IRS, you can designate up to 3 properties but only close on one. You may also be able to designate more properties if they meet certain criteria.
This is the second timing rule you must observe in a 1031 Exchange. You’ll have 180 days once you’ve sold the old property to close on the new one.
Please do note that the two timelines must run simultaneously. For instance, if you designate the new property you wish to buy exactly 45 days later, then you’ll only be left with 135 days to do the closing.
What is “boot” in a 1031 Exchange?
Generally, the goal of using a 1031 Exchange is to delay paying of capital gains taxes. That said, without proper due diligence, you may find yourself liable for capital gains taxes after an exchange.
“Boot” is money that you get from the sale of your property that you don't re-invest in your replacement like-kind property.
So, if you were to sell your property for $300,000 and only re-invest $250,000 into a replacement property, the remaining $50K would be boot, and subject to capital gains tax.
It can take many forms beyond just cash, such as mortage or debt reduction, personal property, or certain closing costs.
The rules regarding boot can be complex, and in the absence of expert advice, you may find yourself inadvertently owing tax due to boot.
The following are ways in which you may be able to avoid boot in a 1031 Exchange.
Trade up in the value of real estate property. In other words, make sure the fair market value of your replacement property is higher than that of the relinquished property.
Reinvest all the money that comes from your relinquished property into the replacement property.
Maintain or increase the debt on the replacement property.
Include personal property on the purchase price of the replacement property.
Arrive with cash when closing to cover for items that the IRS may consider non-like-kind property. This can include tenant security deposits, rent prorations, or outstanding vendor invoices.
Conclusion: 1031 Exchanges in Winston-Salem
As a real estate investor, a 1031 Exchange can be a great way to build wealth. You can use the tax savings to exchange for a better property that offer a high ROI. Be that as it may, the process must be done correctly.
That’s where TE Johnson & Sons comes in. We can help take your investment property to the next level and maximize your ROI. We service the areas of Forsyth, Guilford, Davidson, and Davie Counties in NC. Get in touch to learn more!