DOs and DON’Ts Of a 1031 Exchange

DOs:

Hire a Qualified Intermediary to keep your exchange proceeds.

If you get your hands on the proceeds from the sale of your relinquished property, it will disqualify your 1031 exchange. A Qualified Intermediary is an individual who handles 1031 exchange transferred by the investor.

Identify your replacement property during your identification period.

Investors get 45 days to identify replacement properties, which begins the day the relinquished property is sold.

Use the IRS Identification Rules to your advantage.

The IRS has laid down three different identification rules to meet your replacement needs. The three-property rule, 200% rule, and 95% rule. The three-property rule is the easiest among all, and the majority of investors use this rule.

Reinvest all exchange proceeds if you don’t want to pay taxes.

The amount you save or withdraw from your sale proceeds is taxed normally.

Acquire a property of equal or greater value.

If you acquire a property that is of lesser value than your relinquished property, the money saved will be taxed normally.

DON’Ts: 

Don’t file your income taxes for the year before you complete your exchange.

You must submit all required documents related to your exchange at the time of filing taxes. Therefore, don’t pay your taxes before you complete your exchange.

Don’t reinvest the proceeds in property you already own.

If you do this, you’ll lose the benefits of the 1031 exchange.

Don’t wait until the last minute.

Time plays a crucial role in 1031 exchanges. You have 180 days from the day the relinquished property is sold to acquire a replacement property. Don’t exceed this time, or you’ll lose the benefits of the exchange.

Don’t dissolve partnerships or change the property title during the exchange. 

If you sell your relinquished property, the replacement property must also have your name as the buyer.

Don’t overlook other tax-deferral options.

Though a 1031 exchange is often considered one of the best options when selling an investment property, there are other options too that may provide further flexibility and diversification. For example, the Deferred Sales Trust and the 721 exchange let investors defer capital gain taxes after the sale of a property.