As most people are aware, 1031 refers to the part of the IRS tax code that allows an owner of property to replace real estate property for another piece of property while deferring capital gains tax liability until that second property is resold. Here are four additional ways to use this exchange to your benefit.
Partial Exchange
This occurs when an investor elects to have part of their capital gains tax deferred but accepts responsibility for the remaining portion as “boot”. The individual involved in such an exchange would need to instruct a closing officer about how much cash they plan to have from the relinquished property so that it can be received after this second property is purchased.
Reverse Exchange
In this situation, an exchange coordinator usually ends up on the title for the property being sold or for the property being acquired by the buyer. Usually this happens when a replacement property is located first, so that the second piece of property can be secured. It’s important that this kind of exchange be put together appropriately so as to meet IRS guidelines.
Tenants in Common
This means that two or more individuals have an undivided and fractional interest in a piece of property. Replacing your original investment with a TIC using a 1031 exchange has two benefits: you get the opportunity to invest in a big property while also not having to deal with the property management aspects of the asset. This can also be a great approach for investors who are struggling to identify the right kind of replacement property within the 45 day window for 1031 exchanges.
Improvement Exchange
In some instances, an individual may wish to make repairs on a replacement property or to construct it. While this seems tempting, remember the timeframes involved for a 1031 exchange: the investor only has a 180 day window to complete the work. As anyone who has had construction done can tell you, it’s not always easy to predict a finish date, and going over the deadline could cause you to miss out on the tax benefits of an exchange. Make sure you consult with professionals before initiating this kind of exchange- you need some confidence that you can complete the project in the limited window of time you have.
Before determining whether one of these alternatives could work for you, make sure you think through your ability to complete the exchange in the right amount of time to reap the tax benefits.