When you hear the term 1031, 1031 exchange or 1031 reverse, they all refer to Section 1031 of the U.S. Internal Revenue Code. This law gives you a tax break on the capital gains tax (up to 20% depending on your income bracket) when you sell an investment property and then reinvest that money to buy another investment property of like kind and at least equal value. You can do this by selling your existing property before buying another, or you can buy another investment property and then sell your existing one within the time frame specified by the IRS.
What is a 1031 Exchange
Essentially, it refers to trading one investment property for another as far as tax purposes go. You'll then get a tax break on the capital gains tax owed on the purchase of the property.
How a 1031 Exchange Works
You sell an investment property and then reinvest that money to buy another investment property of like kind and at least equal value. This allows your investment to grow tax-deferred and there is no limit to how frequently you can do a 1031 exchange.
What is a Reverse 1031 Exchange
It works the same way a 1031 exchange does, just a bit backward. Rather than buying the replacement property first, you buy it second within a specified time frame.
How a Reverse 1031 Exchange Works
A 1031 requires that you as the investor cannot hold the proceeds earned from selling an investment property while you find and go through the process of buying the replacement property. Funds must be held by a qualified intermediary. This is a person or company that agrees to facilitate the 1031 exchange by holding all funds involved in the transaction until it's time to buy the replacement property. WaFd Bank is a qualified intermediary, and we can help—contact a local loan officer to find out more.
Requirements for a 1031 Reverse Exchange
There are many specific rules that must be followed for either a reverse or exchange 1031. If you want to take full advantage of what it has to offer, check the IRS rules to find out what parameters and requirements like-kind exchanges must meet to qualify. A few basic requirements are listed below:
- Property exchange must be of like kind, which has a broad definition, but essentially means the two properties must be of similar value.
- There is a time limit—property must be sold (exchange) or bought (reverse exchange) within 45 days and 180 days, respectively.
- A 1031 Exchange Qualified Escrow Agreement (WaFd can provide this for your or you can provide your own agreement)
When a 1031 Makes Sense
Typically only seasoned investors will make use of 1031. It's generally used as a long-term wealth building tool and is commonly used in the following scenarios:
- You want a different property that has better return prospects, or to diversity your assets.
- You want a managed property rather than having to manage one yourself.
- To either divide one property into several assets, or to consolidate several properties into one for estate planning purposes.
WaFd Bank is Here to Help
This can be a complicated process, but you've got experts ready to help you take care of business at WaFd Bank. Contact your local loan officer to get started!