Sam and Mary Lou bought a pasture in 1972 for about $20,000. They are ready to sell it now and know that someone would pay about $80,000 for it. They will incur about $60,000 of capital gain and will be subject to tax on this amount. At the same time, they would like to purchase a pasture closer to their home. Luckily for this couple, the IRC (Internal Revenue Code) allows for real estate owners to defer capital gains tax through a like-kind exchange.
What are the steps involved in a 1031 exchange?
The first step is to hire an attorney or some other appropriate professional who can assist you with the exchange. There are certain documents needed to facilitate the exchange and you will need someone to draft those for you.
The second step is to complete the sale of your real estate. The real estate sold is called the relinquished property. If you are using a real estate agent, tell that person as soon as possible that you are doing an exchange. The most important part of the process is that you cannot receive the proceeds from the sale of your relinquished property. The title company will send your proceeds from the sale to a third party to hold until you purchase your replacement property. If the proceeds are given to you, they are immediately taxable.
The third step is to identify your replacement property and complete the purchase. During the closing, your title company will collect the proceeds from the third party, then apply them towards the purchase price.
What are some things to keep in mind about a 1031 exchange?
There are many rules governing 1031 exchanges. You do not need to learn all of them; a professional can help guide you through the process. Here are a couple of things to keep in mind:
A 1031 takes some time to happen. If you are thinking about doing one, you should talk to a professional as soon as possible. Don’t wait until the week before closing to talk to someone about it, because it could cause delays.
There are certain deadlines after closing that must be met. There is a deadline from the sale of your relinquished property to identify your replacement property. There is also a deadline from the sale of your relinquished property to complete the purchase of your replacement property and officially complete the 1031 exchange.
There are also requirements for the type of property that qualifies for this treatment. The basic rule is that the property must be “investment property”. The IRS has very specific rules for what qualifies as investment property.
A 1031 transaction can sound intimidating, with a lot of information to remember. At Tallgrass Title, our closing agents are specifically trained on how to handle your 1031 exchange.