5 Keys to Mastering Your 1031 Exchange

1.Make decisions based on concrete numbers. Capital gains tax and the motivation to defer those taxes using a 1031 exchange is a complex decision that should be made with as much information as possible. A taxpayer should consider their entire tax scenario, not just the property they are selling, before making a decision to exchange. There may be losses in other business lines to offset the gain on sale and this could decrease the motivation to exchange. Depreciation recapture is often not considered as a tax on sale and could be a motivation to utilize a 1031. Speak to your accountant, compile your true tax situation, and then make decisions based on those numbers.

2.Trust your trusted advisors. There is misinformation about 1031 Exchanges and it is important to know and trust sources of information when researching and planning the transaction. Much of the industry is based on interpretation of tax code from court cases and private letter rulings and requires background knowledge to make educated decisions. Knowing the experience level of your qualified intermediary and your tax advisors can help avoid tax pitfalls. The taxpayer is responsible for the accuracy of their exchange in an audit, not the person offering the advice.

3. Plan ahead. The 45 day deadline in particular makes many investors feel rushed to find suitable replacement property within the strict time frame. This pressure can result in the purchase of less than ideal replacement property or in a failed exchange with taxes due to the IRS. One way of avoiding this scenario is searching for replacement property and backup properties prior to the close of the sales property. Even if the exchangor plans on buying a single replacement property it is suggested to locate and identify a suitable alternative as early as possible. Working with a Tenant In Common or TIC dealer can provide numerous options for cash flowing, management free, real estate investments to identify within the 45 day timeline.

4.Make sure the left hand knows what the right hand is doing. A typical real estate transaction involves multiple parties including realtors, attorneys, accountants, and closing agents. In an exchange the intermediary is also in the loop and it is very important that there is open communication during the process. Delays are common when information is not available to everyone involved and an easy solution is the sharing of contact information during the planning phases. It is also important to alert the buyers of the exchange property and the seller of the replacement property by putting a 1031 addendum in both your sale and purchase contracts agreements.

5.Read and understand your exchange agreement. This document is the backbone of a 1031 Exchange and the composition can vary drastically among qualified intermediaries. There are no regulations on processing 1031 Exchange documentation, so each company must compile their own exchange agreement which leads to a wide variation industry wide. Before signing the exchange agreement at closing, be certain to understand the taxpayer rights and limitations during the exchange period and after. There are several safe harbors outlined in section 1031 of the IRS code and they should be addressed in the exchange agreement to assure a secure exchange.