In today’s financial world, investors know about the long-term benefits of buying and selling investment property. The downside to this investment is the amount of capital gains tax an investor will pay on their sale. Many investors use an investment tool called a 1031 exchange to help lower this tax burden.
If you’re a first-time real estate investor, then read further to learn more about these 1031 exchanges. You’ll discover some built-in benefits that can reduce your tax burden and how our real estate professionals can help you through that process.
What are 1031 Exchanges?
A 1031 tax exchange happens when an investor sells their property and “swaps” the profits from the first sale to purchase another investment property. The perk of this “swap” is that the seller doesn’t pay any capital gains taxes on their sale because the proceeds don’t reach their bank account. Any profit goes towards buying another property.
The sold property needs to be an equal or higher value than the purchased property. No funds can be exchanged and there should also be no debt relief to sidestep extra taxes.
1031 exchanges get their name from Section 1031 of the US Internal Revenue Code. A 1031 exchange applies to only commercial property or vacant land and not a person’s residence. That’s why this process is an attractive means to buy rental properties.
What’s a 1031 Tax Exchange Company?
A 1031 tax exchange company facilitates sales between buyers and sellers. These companies will sell your existing property and buy your new property on your behalf. They also hang onto your sales proceeds and then apply them to the new property transaction.
Other tasks that 1031 tax exchange companies will provide include:
- Coordinate with sellers and buyers on the arrangements for a 1031 exchange;
- Draft the required documents pertaining to the sold property and the replacement property;
- Present this documentation and any specific instructions to the title or escrow companies;
- Draft an arms-length affidavit between property sellers and buyers;
- Deliver the conveyance of sold property to the new property owner on behalf of the seller; and
- Submit the necessary 1099 form that reports any income the seller receives through the year from other non-personal income sources; and
- Complete other necessary legal documents to comply with guidelines from the IRS.
What Are Your Next Steps?
Before you meet with potential companies to represent you, do your homework first. Read up on the requirements for 1031 tax exchanges and familiarize yourself with any IRS rules. Ask your family and friends for company referrals.
When you meet with exchange company representatives, ask them to share a statement of their errors and omissions insurance. Request to see proof of their fidelity insurance. When you see this evidence, you can feel certain that your investments will be protected against negligence or fraud.
Contact your nearest local escrow officer and ask them for their recommendation. They could have suggestions on which companies can represent your transaction.
If you’re still unsure about real estate investing, you can also check our website for more advice. For example, we have a helpful investment tool that can help you see variables that affect rental property performance. We’re your Philadelphia team that can help you with your property needs.
