A 1031 exchange is a strategy that many savvy investors use to defer capital gains taxes, reinvest in new property and build wealth along the way.
In simple terms, it allows you to sell a property and reinvest the proceeds in a new property while deferring capital gains taxes. The tax is postponed until you sell the new property without doing another exchange.
However, there are several different types of 1031 exchanges, each with its own unique advantages. If you’re considering a 1031 exchange as an investment strategy, learning about these types can help you find the perfect exchange for your goals.
Simultaneous exchange: The simplest one
In a simultaneous exchange, the sale of the relinquished property and the purchase of the replacement property happens on the same day. It is a straightforward swap of one property for another.
While it is the most straightforward, it is also the least common due to the difficulty in timing both transactions to occur simultaneously.
Delayed exchange: The most common type
The delayed exchange is the most common type of 1031 exchange. This is how it usually works:
- You sell the property
- You identify a potential replacement property within 45 days of the sale
- You complete the purchase of the new property within 180 days of the sale
A qualified intermediary will hold the funds from the sale during this period. If you accept that money, it will become taxable and therefore undermine the purpose of the 1031 exchange.
Delayed exchanges are the most common because they offer more flexibility in finding a suitable replacement property. In 1031 exchanges, you have to find a like-kind property, similar to the original property. This can be easier said than done, which is why the time allowance of a delayed exchange is beneficial.
Reverse exchange: The exchange for great opportunities
A reverse exchange occurs when you buy a replacement property before selling the relinquished property. This can be useful when a great investment opportunity arises, but you have not sold your current property yet.
You have 45 days to declare the old property as relinquished. Then, you must complete the exchange within 135 days.
However, reverse exchanges can be more complex and expensive than other types. It involves creating a special entity to hold the new property until you sell the new one.
1031 exchanges can be great wealth-building tools when done right. Consider talking to a real estate attorney who can guide you through the process and help maximize your tax benefits.