1031 Exchange: The Most Powerful Process in Real Estate

June 12, 2024 | 

Navigating the 1031 Exchange Process in Real Estate

A 1031 Exchange, in short, is a way for investors to sell an income property and defer the capital gains taxes by buying a new income property (replacement property). A common question from investors is, “When should I start working on my exchange if I know what I am going to sell?” When it comes to planning, there is no such thing as “too early” for an exchange. The more you understand the investment market and process, the more likely you are to make a solid investment decision.

Over the last few years, upwards of 50% of our company’s transactions have involved an investor with a 1031 exchange. With the amount of sale activity in the real estate market due to the increased values, investors have been utilizing the 1031 exchange to protect their capital. If done correctly, with a plan, investors can achieve their financial objectives. If done without a plan, investors can find themselves rushing into the purchase of a bad property and may have been better off paying taxes.

Benefits of Planning Early

Successful exchanges start with a strong plan – understanding the components of the exchange, the timing, and involving the right team early on. Investors should understand the property type they are seeking, expectations of return, debt needed (if applicable), price point, team (attorney, accountant, broker, intermediary), and timing of the process – starting the exchange process before an investor is closing the sale of a property is key. Taking these steps before an exchange better prepares an investor and allows them to find a good property matching their investment criteria. In the world of real estate exchanges, it could cost hundreds of thousands of dollars – maybe millions if the wrong property is purchased, or worse, the exchange doesn’t go through, and you pay the taxes.

Many of the best deals are done off market. That means if an investor is only looking at properties on the market, they may have a difficult time finding the best opportunities. Trying to learn which property type you want, where you want to invest, and figuring out the investment market while simultaneously looking for a replacement property can be a recipe for disaster.

Key Components for a Successful 1031 Exchange

Plan Ahead for a Successful Exchange

The best advice for investors who are considering selling an income property and interested in an exchange is:

Consulting Your Accountant

Meet with your accountant to understand your tax consequences and how an exchange could work for you.

Working with an Investment Broker

Meet with an investment broker who can put a plan in place based on the amount you will exchange and your investment criteria for the exchange property.

Listing Your Property

Once you feel comfortable with the options and still want to proceed with the exchange, put your property on the market for sale. Having an exchange plan in place eliminates any concern of what to do after your property sells.

Engaging an Intermediary

During the time you are in escrow, put an intermediary in place – this is an integral part of the exchange process. The intermediary is a company that will hold your funds after the close of escrow on the sold property until the close of escrow on the exchange property.

Arranging Financing

If debt is needed, meet with lenders to discuss your financing options, and submit all the information needed to line up your loan.

A 1031 exchange can be a great way to get out of an asset that doesn’t fit future investment goals and into an asset that makes sense for the future. Reduce your risk of making a mistake and talk to professionals before you make any decisions to sell a property. Work together to create a successful plan for the exchange!

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