3 Things Every Investor Should Know About 1031 Transactions

3 Things Every Investor Should Know About 1031 Transactions

A year or so ago, we published a blog post discussing how investors could use hard money loans to complete time-sensitive 1031 transactions. Not much has changed regarding 1031 rules since then. However, the topic deserves to be revisited as we head into another tax season.

Known as the 1031 Exchange, a 1031 transaction is a real estate transaction conducted under the rules of Section 1031 of the Internal Revenue Code. The rules allow investors to defer capital gains taxes by taking the proceeds of a property sale and using them to invest in a new project.

The transactions are valuable to investors in the sense that they allow for reinvesting profits rather than paying them to the federal government. Just note that taxes are never avoided completely. They are simply deferred for the time being. With all that said, here are three things every investor should know about 1031 transactions:

1. Not All Properties Are Eligible

One of the biggest restrictions of 1031 Exchange rules involves eligible properties. First and foremost, only business or investment properties qualify. Personal residences and vacation homes do not. Also, fix-and-flip properties generally do not qualify unless they are rented for a time before being disposed of. What is the difference?

Rental properties are considered long-term investments by the IRS. So even if you purchased a property that you eventually intended to flip, it still might qualify for a 1031 transaction if you rent it for several years before selling. In that sense, it is no longer a fix-and-flip. It is an investment property.

For the record, Actium Partners does not provide fix-and-flip loans. We do provide hard money and bridge loans for acquiring investment properties. In fact, many of our clients utilize hard money loans to complete the acquisition portion of a 1031 transaction.

2. The Qualified Intermediary Requirement

IRS 1031 rules stipulates that, in most cases, investors are required to use a Qualified Intermediary (QI) to facilitate the transaction. Even if one was not required for a given project, using one is still a good idea. A QI is an individual or firm whose job is to facilitate the sale of the currently held property, hold on to the proceeds, and then help facilitate the acquisition of the new property.

In many cases, a QI either works for a title company or has an ongoing relationship with one. At any rate, it pays to do your due diligence when selecting a QI. That person or firm is going to play a huge role in making sure the 1031 transaction is conducted by the book.

3. Transactions Are Time Sensitive

IRS rules are structured in such a way as to prevent 1031 transactions from being open-ended. The transactions are time sensitive, based on two deadlines. Your first deadline applies to identifying a replacement property following the sale of the currently held property. You have 45 days from the date the sale is closed.

Rules allow for identifying up to three potential properties just in case your preferred property falls through. Once those properties are identified, you are facing your next deadline. You have 180 days from the date of the sale of your currently held property to obtain a replacement property.

The two deadlines do not represent an awful lot of time in the investment property arena. That is where hard money comes into play. Once you close on your currently held property, the clock starts ticking. Hard money could be the key to you obtaining a piece of property quickly enough to complete a 1031 transaction and defer your capital gains.