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You are here: Home / Finance / What is a 1031 Exchange and How Does It Work?
What is a 1031 Exchange and How Does It Work?

What is a 1031 Exchange and How Does It Work?

December 1, 2021 By Cade Hildreth Leave a Comment

How would you like to build your personal wealth faster? If you’re taking advantage of the burgeoning real estate market, you may be wondering how to scale up without getting penalized by Uncle Sam.

Between income generation and appreciation, real estate can build lasting wealth more reliably and consistently than other investments. But how do you grow your portfolio in the most cost-effective way?

Read on to find out how a 1031 Exchange can help you invest in income-generating properties on a larger scale than before.

What is a 1031 Exchange?

A 1031 Exchange, sometimes called a “like-kind” or Starker exchange, allows you to sell an investment property and defer the capital gains tax to invest in a replacement property.

Depending on your income, capital gains can strip you of as much as 20% of the profit from your investment.

Here’s a quick summary of the various types of 1031 exchanges.

1. Simultaneous Exchange

A 1031 Exchange can be a real swap of properties: Two investors simply swap properties of equal value with neither paying the tax. This isn’t a common occurrence, however.

2. Delayed Exchange

A delayed exchange lets you sell your property and then find another one to purchase, while still deferring the tax. In a delayed exchange, you have 45 days to find and identify a new investment property and up to 180 days to close the sale.

3. Reverse Exchange

If you have cash for your next investment, you can do a Reverse Exchange and still defer the capital gains tax. In this case, you purchase your new investment before selling the old one.

The benefit is the same — you can still defer the capital gains tax. On the downside, you have to have the cash upfront and need to sell the original property within the 180-day window.

1031 Exchange Rules

Like any process under the auspices of the IRS, there are a few important 1031 Exchange rules. There are also some newer restrictions.

1. Equal or Higher Value

The most important of the 1031 Exchange rules applies to the value of the properties. The new property must be of equal or higher value than the property sold.

2. Like-Kind

To qualify for the deferment, both properties must be of “like-kind.” That means similar in nature, such as swapping an apartment complex for a rental duplex.

On the upside, you can exchange one apartment building for two single-family homes, as long as the newly acquired properties together are of equal or higher value and both are used as investments. This is because both are income producing rental properties, which make them “like-kind.”

3. Same Tax Payer Rule

To comply with 1031, the taxpayer must be the same on the old property as on the new one. There is a handy workaround, however, for sole-proprietor LLCs. If you were the sole owner of a property, you can transfer the replacement property to your sole proprietor LLC.

4. Qualified Intermediary

In order to qualify for a 1031 Exchange tax deferment, the capital from the sale of the original property must be held by an independent third party, called the Qualified Intermediary or QI.

Generally, this is a fiduciary firm that holds the proceeds on account, similar to an escrow account. Once the purchase property has been identified, the QI will disperse the funds at closing.

What are the Benefits of a 1031 Exchange?

When you do an exchange, you can defer the capital gains tax on any investment property you sell and invest them into expanding your portfolio. This gives you more equity in your new investments.

If you’re considering getting into the house-flipping game, following the 1031 Exchange rules can keep more of your money working for you.

A 1301 Exchange also allows you to take advantage of real estate trends. If the market in your current investment has leveled out, you can sell and invest your money into property in an up-and-coming neighborhood.

You can also change the nature of your investment without getting penalized by the capital gains tax. You can take on new business opportunities, such as selling one of your single-family rentals to purchase vacation rentals.

How Does the 1031 Exchange Build Wealth?

By deferring the capital gains tax on the sale of your investment properties, you retain more equity in your purchase. So, when it’s time to sell your property, you’ll see more cash on the table.

That can be a critical difference if you rely on mortgages to invest in real estate. The amount of interest you pay the bank is based on how much you borrow, not on the sale price. So, if you can walk into new investments with more money upfront, you’ll save on financing.

And if you’re building a portfolio of income properties, deferring capital gains taxes lets you scale up in doable increments. With more money down, you can widen your net when it comes to buying new properties.

So, When Do You Pay Tax?

Nothing good lasts forever, so, of course, you’ll eventually pay taxes. Internal Revenue Code, Section 1031 allows you to defer the payment of capital gains taxes until you sell the replacement property.

You may also pay it with increased income taxes as part of depreciation recapture if you’ve been using depreciation as a deduction. Should you sell the property for more than the depreciated value, the difference becomes taxable income. This is calculated separately from your capital gains tax.

Capital gains taxes may also come due as a tax on an estate after the owner’s death.

Simple Steps for a 1031 Exchange

The process seems overwhelming, but you can break it down into a few simple steps:

  1. Market and sell your existing investment property
  2. Entrust your gains with a QI
  3. Find a like-kind investment property within 45 days
  4. Make an offer on the new property and negotiate a contract
  5. Have your QI disperse funds to the seller of the replacement property
  6. Fill out a Form 8824, Like-Kind Exchanges, for the IRS

Summarizing the 1031 Exchange

You don’t have to be a real estate mogul to take advantage of the 1031 Exchange tax deferment rule. Between 2011 and 2014, 48% of 1031 transactions involved individual investors.

The 1031 like-kind Exchanges is perfect for small business and investors. The ability to reinvest what would have gone to the IRS can provide substantial purchasing power while building your portfolio.

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“As an LGBTQ+ entrepreneur, real estate investor, former USA Rugby Player, and fitness fanatic, I’ll teach you what your parents and teachers should’ve taught you, but didn’t know themselves.” -Cade Hildreth

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Because it’s the New Year, let’s talk about ch Because it’s the New Year, let’s talk about change...

For a long time, I’ve thought about top surgery. I remember when I was 6 or 7 years old when I wanted to run around outside on a hot, sunny day with my shirt off…and I first saw my parents… hesitate. Ughh. 

It wasn’t their fault but I still remember that heart wrenching feeling. To their credit, they ultimately said, “Ok, go do it!” While I did “do it”, I remember the feeling of shame that crept in.

Over the years, being in affirming sporting/rugby circles helped suppress the urge to get top surgery, but it never quite “stayed down.”

So last summer I got keyhole #topsurgery. I’ll talk about recovery in another post because it was definitely weird to not strength train for months.

But in THIS post, I want to share two things:

1. I am SO grateful to my wife Erin for being the supportive and growth oriented partner that she is. 🥰🙏❤️ 

She is now following her call to get a divinity degree and she’s already working in ministry as a Pastor in Training at an incredible, inclusive Presbyterian church here in Virginia. I am grateful to her for supporting me as I become more and more of who I am—and I’m enjoying watching her do the same! Love you, babe!

2. Second, I’m grateful to get to share who I am with my family. This summer we took a trip to Madden’s resort in MN to celebrate my parent’s 50th wedding anniversary. (It was actually their 52nd, because we had to postpone it twice due to Covid.)

I was nervous to be in the pools and lakes around them, but I could feel it was my only choice because I knew I wanted them to “know me”. And, how could that happen if I “hid me”?

Ultimately, I have to tell you…it was freeing to be me, as I am, who I am. 

I had the BEST time splashing around and biking and goofing around with my wife, niece, nephew, & sister. 🌊🏖🐟

So, I suppose, this is a gratitude post to thank those who have supported me over the years as I become more and more of who I am. 

Top of that list is my wife, Erin, but there are countless others. ❤️

If you’re reading this, thank YOU for being one of those people in my life too. I am deeply grateful. 🥹
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#lgbtqfamily #nonbinary
How to set a boundary? 🤔 . . . . #lgbtqia #lgb How to set a boundary? 🤔 
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#lgbtqia #lgbtqcommunity #emotionalhealth
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1. Good and bad are labels. All things are experiences. 

2. Maturity is taking full responsibility for oneself. 

3. Having a loving, conscious relationship with myself is a core value. 

4. Emotions do not mean that anything has to be done. 

5. When I am in congruence with what I want, I have it. 

6. I have permission from myself to stop doing anything that doesn’t lead to my peace and empowerment. 

7. Stepping toward emotions and being able to feel them is a superpower. It determines the quality of my life. 

(Are there any above that you’d like me to further explain?)
 
Most importantly, which # above resonates with you? ⬆️

Happy New Year, y’all! 🎊🥳
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#lgbtqcommunity #lgbtqiaplus #lgbtsupport #nonbinary #trans #selfgrowth
Interview with Jenny Nguyen, Founder of the Sports Interview with Jenny Nguyen, Founder of the Sports Bra—The World's 1st Bar to Only Play Women's Sports - shorturl.at/doGHZ

I'm excited to introduce you to today's #podcast guest, Jenny Nguyen, who is a professional chef, elite athlete, and entrepreneur.

I invited Jenny onto the podcast because she has done something extraordinary that is long overdue: She has opened up a sports bar that exclusively plays women's sports!

Despite extensive research, Jenny hasn't found another sports bar worldwide that ONLY plays women’s sports.

Given that it's nearly 2023, this is mind-blowing. As a lifelong athlete, I find her vision compelling and inspiring.

Aptly called the "The Sports Bra", the venue is putting Jenny's culinary skills on display alongside women's sports worldwide.

The Sports Bar has taken its mission a even further by partnering with and elevating other local, women-owned businesses.

Specifically, it:

1. Sources its grass-fed beef from @CarmanRanch, an ranch run by Cory Carman, a third gen rancher out of Wallowa, Oregon).

2. Sources its alcohol from Freeland Spirits, an all-women owned and operated distillery out of NW Portland.

3. Has furniture built by @girlsbuild_org, a non-profit organization headed by @ktmhughes in Portland, OR, that teaches carpentry and construction skills to young girls as a path to empowerment.

Since opening the Sports Bra this April, people have come from ALL over the U.S. and the world to experience it—including many professional female athletes.

To learn more about Jenny as she makes history, features women's sports, and elevates women-run businesses, listen to the episode here:

shorturl.at/doGHZ

Or, you can check out the Sports Bra at:

@thesportsbrapdx
TheSportsBraPDX.com/

Have you heard of the Sports Bra or been out to experience it in person?

#lgbtqiaplus #womenownedbusiness #lgbgtqia #lgbtqcommunity #womenssports #womeninsport
Over this recent holiday stretch, we… - enjoye Over this recent holiday stretch, we… 

- enjoyed some quiet time at home
- got a sauna delivered (but not yet installed)
- decorated for the holidays
- baked a bunch
- visited our favorite farm
- did some sight seeing
- and perhaps, most importantly, survived the cold snap along with our feather friends (who lived in the garage for a few days so we could heat them with a space heater) 🥶🐔

How have the holidays treated you…and did you get hit by the winter storms? ❤️🎁☃️❄️
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