Dos and don’ts in 1031 exchange

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It is commonly known that the main purpose of 1031 exchange is to swap one investment asset or business to another. These swaps are usually taxable as sales, but if investors come within the 1031 exchange, the tax will either be none or significantly reduced when the exchange is performed. However, in order to benefit from the best results, there are some 1031 exchange rules you need to follow, so here are the dos and don’ts related to this type of swap.

Do – pay attention to time

You should know that like-kind exchange, which implies swapping a business or asset for a similar one, provide investors a period of 180 days in order to complete the transaction. This period also includes those 45 days the investor has to identify the replacement property he or she is interested in buying. You should know that weekends and holidays are also included in this period, without any exception, so make sure you do your counting very well.

Do – exchange for a property that is either equal or greater in value

If you exchange for a property that is lower in value than yours, the money you do not spend will be considered capital gains and you will be taxed for them. Make sure the replacement property you are interested in buying has the value equal to yours in order to avoid any such situations from happening.

Do – replace your debt

It is worth mentioning that you can create a taxable event if you decide to take out a mortgage at a level that is lower than the initial one, which automatically makes you bring some extra cash to the transaction itself. It is highly recommended to ask your representative for more information in case you decide for a lower mortgage payment.

Don’t – assume you can make the exchange with a second home

Vacation properties are not used by people to live there for more than two weeks a year or are rented nearly 10% of the time. This means that in order to be able to qualify for a 1031 exchange, it is mandatory for the vacation property to be either an investment or used in business or trade.

Don’t – forget to establish the exchange before the transaction actually closes

When establishing the purchase agreement, it is recommended to include a stipulation in order to transfer the funds from a specific property’s sale to a qualified middleman and not directly to the sellers when the closing time approaches. This way, you can make sure you will benefit from the best results and the transaction is done without any incidents.

Don’t – ignore recapture

Another important rule you need to keep in mind when it comes to 1031 exchange is to not ignore recapture. You should be able to deduce from the basis of the property any depreciation that might exist and that might have been previously taken by an investor and this action should be performed before calculating the gains.

As you can see, these are the main rules you should consider when engaging in a 1031 exchange.