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Quick Guide: 1031 Real Estate Exchange For Real Estate Investors in California

If you are a real estate investor who has a property that you want to sell, you might want to look into a 1031 real estate exchange to maximize your investment fund. This tax-deferring strategy can help you in the sale of one property and the acquisition of another, thus increasing your net worth.

Below are the most important things to keep in mind about 1031 exchange rules in California.

What Is A 1031 Exchange in California?

1031 exchange came from Section 1031 of the United States Internal Revenue Code, which lets you sell investment property without having to pay capital gain taxes. Within specific time constraints, it permits you to reinvest the sale earnings in a real estate property of equal or greater worth.

Capital gain taxes are typically levied on the sale of your present investment property when exchanging it for a new one. But if your transaction qualifies for a 1031 exchange, you can delay these taxes for as long as you like. It gives investors the freedom to switch to a different type of property or focus on a different location without having to pay a hefty amount in taxes.

4 Types Of Real Estate Exchange

Consider the following types of real estate exchanges if you intend to engage in a 1031 exchange.

Simultaneous Exchange

It is a form of 1031 exchange that occurs when the property you’re selling and the property you’re acquiring closes simultaneously. Remember that this transaction must coincide for you to get the benefits. Exchanging properties may be deemed invalid if the closing on either property is delayed, even for a short time.

There are a variety of ways in which a simultaneous exchange might occur. The first type involves exchanging deeds with the seller of the other real estate property. The other one is an exchange in which a qualified intermediary facilitates the deal for both you and the seller of the other investment property.

As a qualified intermediary, they will organize the transaction and have the necessary expertise and experience to handle such transactions. You risk invalidating the 1031 exchange without their assistance and triggering a substantial tax liability.

Delayed Exchange

A delayed exchange is by far the most common kind of 1031 exchange. When doing a delayed exchange, you are allowed to sell your investment property before acquiring another investment property. You can then utilize the money from the sale of one property to support the purchase of another.

When a like-kind property is purchased by the seller, a middleman must be hired to hold the sale funds until the transaction is completed. It will be hard to do this transaction unless you’ve advertised your home, found a buyer, and finalized the sale and purchase agreement.

Reverse Exchange

You identify and acquire a new investment property in a reverse exchange prior to selling your present real property. Then, your present property will be exchanged. By acquiring a new property in advance, you can delay the sale of your current property until its market value improves.

The biggest problem with this transaction is that it often involves a cash-only transaction. In addition, it is crucial to note that most banks do not offer reverse exchange loans.

Construction Or Improvement Exchange

You can improve a property before exchanging it in a construction or improvement exchange. During the 180-day holding period, you can utilize the trading capital to make modifications while an intermediary holds the property.

1031 Exchange California Time Limit

1031 exchange time limit

Traditionally, an exchange includes two parties exchanging one thing for another. However, the likelihood of finding a person with the property you want who also wants the property you own is low. As a result, most transactions are either delayed or three-party in nature.

After selling your home, you need a certified intermediary to retain the funds and utilize them to buy a new one. Exchanges between three parties are handled in the same way as a swap.

In a 1031 exchange, there is a critical 1031 exchange time limit that you must adhere to.

45-Day Rule

The first involves the selection of a comparable property. Once your property is sold, the intermediary will get the payment.

You cannot receive the cash, as doing so would invalidate the 1031 exchange. In addition, within 45 days following the sale of your home, you must write to the intermediary indicating the property you wish to buy.

You may specify up to three properties, provided that you ultimately close on one. In some cases, you can designate more than three, provided they meet particular value criteria.

180-Day Rule

The second rule of time pertains to closing. Once the old property is sold, you must settle on a new one within 180 days. The two timelines run simultaneously, so you must begin counting as soon as your property closes.

Choosing A Replacement Property

The nature of a property determines whether it is considered like-kind. Because of this, there is a wide range of properties that may be exchanged for one another. For example, vacant land can be swapped for a residential property, and commercial estate can be traded for an industrial property. However, this must be an investment property, not one that is sold or used for personal purposes.

Your new property must be worth at least as much as your old one to qualify for the 1031 exchange benefits. Within 45 days from the closing of your property, you must locate a substitute property and close the deal within 180 days.

There are three applicable rules for identifying replacement property. First is the three-property rule, allowing you to select three properties as possible investments irrespective of market value. Second is the 200% rule that permits an unlimited number of replacement properties so long as their total worth does not exceed 200% of the value of the property sold. The 95% rule, on the other hand, permits you to identify as many properties as you choose as long as you purchase properties worth at least 95% of the total.

Bottom Line

1031 real estate exchange can be advantageous in various ways for investors. Hence, it is an excellent option if you wish to diversify your investments or acquire a property that offers a better-estimated return.

It is important to keep in mind that while you now know what 1031 exchange is, it is a complex procedure that requires expertise. Thus, you must ensure that you have skilled professionals on your side, such as 1031 exchange specialists, accountants, and attorneys who are fully acquainted with this procedure. 

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