Before jumping into a 1031 exchange, there are some important things you should know that might save you a lot of headache down the road.
Any cash you receive will be taxed.
Once you have purchased an investment property, any cash you have remaining from the sold property can and will be taxed as a capital gain. Take this into account when deciding how much you want to put towards another property.
Broad terms can be dangerous.
A 1031 exchange only requires that the next property be “like-kind” which could mean any number of things and can be very misleading. With a 1031 you can exchange a land lot for a condo, or an industrial building for a strip mall. Be warned though, you can get yourself into tax trouble if the 1031 exchange is not true like for like exchange.
You must consider mortgages and other debt.
To protect yourself, you need to take a look at any loans or other debts on the property you are planning on letting go of and look at the cost of the property you are replacing it with. Think of it this way… if the property you were going to sell had a $1 million mortgage but your new property is being purchased for $900,000. You will have $100,000 of capital gains and it will be taxed heavily.
Your next property must be selected.
If you decide to delay your 1031 exchange, there are two rules that you must take into consideration. Once you sell your initial property, a third party will receive the funds. If you receive the cash, it will end the 1031 exchange. The first rule states that replacement property options must be identified within 45 days of closing on the subject property. The second rule states that within 6 months of the sale, you must subsequently have completed the purchase of the replacement property. You must keep the 1031 facilitator in the loop with your activities during the transactions.
Using a 1031 exchange for personal use is a big No No.
A 1031 exchange is only for investment and business property, so you can’t swap your primary residence for another home. There are ways you can use a 1031 for swapping vacation homes, but this loophole is much narrower than it used to be. It’s also good to note that that exchanges of corporate stock or partnership interests don’t qualify but interests as a tenant in common in real estate do.