To see if it is for you, you need to identify your goals to determine your best path forward.

But first, let’s summarize what a 1031 exchange is...

IRS code section 1031 allows for the exchange of investment properties that are like-kind, allowing the investor to reinvest and defer capital gains tax.

Like-kind property meaning the property you are acquiring has to be of equal or greater value than the property you have relinquished. 

What it doesn’t mean is that the property has to be the same kind of property. If you have residential you aren’t stuck with only exchanging into another residential property. You can exchange residential property for commercial, raw land, or visa versa as long as the value is the same or greater.

However, the property can not be personal property it must be US property used for business or investment, and the title of both properties must be in the same tax payer’s name.

A challenge of the 1031 is you have only 45 days from closing on your relinquished property to identify a new property, and 180 days to close the deal.

You may be wondering if a 1031 makes sense for your situation, this will depend upon your goals, like…

• When do you want to liquidate?
• Type of exchange you are seeking?
• Are you wanting to be an active or passive investor?

Real estate has long been known as a means to generate wealth. Investing in real estate, however, also means your cash is tied up. A 1031 exchange is used to defer capital gains. A great strategy to retain more cash to reinvest, but also delaying liquidation because you are once more tying up your cash into a new investment.

We discussed this already, but obviously your property goals may affect a 1031. The biggest caveat is it is only for investment or business properties. 

For instance, if you want to sell or acquire a secondary home or vacation home this is considered personal property. However, if rented out as a vacation home and if it meets the criteria then it may still qualify for a 1031 exchange.

A 1031 is for the active investor. You can continue to use it to roll into new investment properties deferring capital gains until the day you are ready to hang up your active investing spurs.

If you have been actively investing and using the 1031’s and are now wanting to transition to a more passive investment approach you do still have options to maintain capital gains tax deferment while transitioning into passive real estate investments, one option is to roll your 1031 into a DST. 

Find a qualified real estate accountant or attorney that knows the ins and outs of a 1031, and identify a qualified intermediary per IRS code, which is a non-related third party that retains the funds during the exchange period. 

Improperly prepared 1031s can result in capital gain burdens for the taxpayer. An experienced CPA or real estate attorney can ease you through the process, along with DSTs. 

• Recap
• Upsides
• More money to reinvest by deferring capital gains
• Opportunity to exchange into better investments
• 1031 exchanges can continue to roll over into property after property
• A tool to mitigate the increase in taxable income from the recapture of depreciation

Can’t be used with personal properties. However, it is possible for vacation rental homes if set up correctly. 

When you are ready to cash out, taxes catch up with you.

You have only 45 days to find your new property. Depending upon the market this can be challenging to try and find a profitable investment in such a small window.

Conclusion

A 1031 is a great strategy to increase wealth by gaining better control over the quality of your real estate holding. By exchanging properties this tool provides a tax advantage to avoid depreciation recapture and to have more money to reinvest. 

If you reach a point of no longer wanting to actively invest you can sell a 1031 property, and passively invest into a DST to maintain the capital gains deferment. A qualified CPA or real estate attorney can guide you through properly executing a 1031 exchange.