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What Is a 1031 Exchange?

Have you ever heard the phrase “everything I ever needed to know about life I learned in Kindergarten?” Would you believe that it applies to processes like 1031 exchanges?

Reflecting back on Kindergarten is a classic parental go-to for a reason. Because while there are plenty of important life skills you probably didn’t learn in grade school (like, let’s say, the easiest way to get Cubs season tickets in a prime location), there are plenty of handy life skills you did probably come away with – even if you didn’t realize it at the time.

For example, a lot of what you need to know to succeed as a real estate investor or developer, you probably learned in the schoolyard. (And no, that’s not meant to be a burn or anything!) Learning how to play fair, how to wait your turn, how to pick the best possible team for kickball… Those are all valuable life lessons that come up in business every day.

Another thing you might have picked up at recess? Swapping! Remember when whole groups of kids would come together and discuss whether a bag of chips was of equal value to an apple? Or if a Ken Griffey Jr. baseball card was worth as much as a Darryl Strawberry? And then, of course, there would be all kinds of new rules invented. Like, you could only trade a Kit Kat for a bag of Skittles if there were at least 33 Skittles in the bag. Or, you could trade one sandwich for another as long as they came on the same kind of bread.

In a lot of ways, those childhood trades were great prep for a very adult process, one that’s of particular interest to developers and real estate investors: the 1031 exchange.

What Is a 1031 Exchange?

A 1031 exchange, also called a “like kind exchange,” is an exception that allows property owners to postpone paying tax on any gains if they reinvest the proceeds in similar property as part of a qualifying “swap.”

In other words, a 1031 exchange allows you to defer paying taxes on the appreciated value of a property, as long as you put it right back into a similar investment vehicle of equal or greater value. Bear in mind that this exchange can include like-kind property exclusively, but it may also include like-kind property along with cash, liabilities and property that are not like-kind.

The appeal, then? These types of tax-deffered exchanges allow investors to put off capital gain taxes, all while also helping to potentially facilitate significant portfolio growth and increase their return on investment.

There are a few more things to keep in mind. For one thing, it’s important to note that 1031 exchanges are structured exchanges, where  the disposition of the relinquished property and the acquisition of the replacement property must be mutually dependent parts of an integrated transaction, constituting an exchange of property. Selling one property and simply reinvesting the proceeds into another one does not qualify.

While a simultaneous swap is arguably the most common type of 1031 exchange, there are other types of swaps that might work – such as a deferred exchange, or a reverse exchange.

What Types of Property Qualify for a 1031 Exchange?

Broadly speaking, most types of property held for productive use in a business or for investment can be exchanged for like-kind property. Both properties must meet this standard. In other words, property that is used primarily for personal use – like, say, a primary residence or a vacation home – does not qualify.

Another point to keep in mind is that both properties must be similar enough to be considered “like kind” – property of the same nature, character, or class. But with that said, this is a broad designation. For instance, most real estate is considered like kind with other real estate, even if the properties being exchanged are a commercial building and vacant land.

Are There Time Limits or Restrictions to a 1031 Exchange?

Considering a “like kind” swap? There are a few deadlines to keep in mind. These have to be met in order for the exchange to qualify.

First, you have 45 days from the date you sell the original property to identify potential replacement properties. This identification must be in writing, and submitted to a qualified individual, such as the seller of the property or an intermediary.

Then, you have until day 180 (from the date of sale) to close on the intended replacement properties. During this time, the investor must bring on a qualified intermediary – who may not be a real estate broker or financial advisor – to successfully complete the exchange.

Navigating the World of Chicago Real Estate

Have any more questions about 1031 exchanges – or any other aspect of buying, selling, developing, or investing in real estate in Chicagoland?

The experienced team at Gunderson Law Firm handles:

  • residential and commercial purchase & sale agreements
  • mortgage conveyancing
  • property tax appeals
  • landlord/tenant disputes
  • pre-marketing planning consultations
  • Litigation
  • leases, including title examinations and advice on insurance and financing

For developers and investors, the Gunderson Law Firm possesses the expertise and insight necessary to make the most of your time and budget – all reinforced by years of experience and long-term connections throughout Chicago’s real estate, finance, and insurance industries. Drop us a line today to learn more or schedule your free initial consultation.

2018-08-21T12:15:58-05:00 August 28th, 2018|Community|