1031 Tax Deferred Exchange

For a first-time homebuyer, a section on tax deferred exchanges may appear to be a little far out. But, this underutilized financial tool can make a big difference in the following situations: (1) You want to keep your starter home for a rental when you move up. (2) You’ve rented part of your home and it’s subject to capital gains. (3) You want to trade your single family up to a duplex or fourplex. (4) Someone has an investment property (single-family rental, duplex, or even new construction) you would like, but if this person sold, capital gains would kick in. The possibilities are endless for creating win-win deals and deferring capital gains to a time when the tax bite is not so painful. Unfortunately, paying capital gains taxes keeps many owners from selling single-family homes and condos they’ve owned for years and would like to unload. These properties may be homes they couldn’t sell in a slow market, so they rented them. Eventually, the market changes, and suddenly the rental has lots of equity and a growing tax liability.
Not wanting to go through the pain of fixing up the property and putting it on the market, many owners continue living with the problem and delaying doing something proactive. As equity grows, the problem also grows for many owners.
Luckily, a 1031 exchange may be able to solve their problem by getting them into something more suited to their interests. Putting an exchange together is fairly straightforward but may require the expertise of an exchange intermediary, accountant, and a title/escrow company depending on the number of properties and complexity.
The exchange intermediary is the neutral party that handles the nuts and bolts of the exchange. To find one, look in the yellow pages or check the Internet under Real Estate Exchange. Or better still, realtors and title companies who do 1031 exchanges will be able to recommend good intermediaries. You’ll also need a title or escrow company to handle title work and funding, and, of course, the buyers and sellers for the properties in the exchange.
The exciting thing about 1031 exchanges is that you don’t have to have two property owners who want to exchange straight across; you can bring in other buyers and sellers with their properties to add to the mix.
Here’s a simplified example: you find a buyer for the property you want to get rid of (relinquished property), and the sale goes into escrow. You have 45 days to find a property you want to buy (replacement property), and that goes into the escrow. The buy/sell mix closes, and you end up with the property you want. The party with the least equity can use cash or financing to make up the difference.