Everything You Need to Know About 1031 Exchanges in Texas

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The term “1031 Exchange” originates from section 1031 of the Internal Revenue Code. This permits an investor to substitute their investment property with another one that is similar or labeled as “like-kind”. The investor is given an option to defer the capital gain taxes temporarily.

Investors are open to using the 1031 exchange since they can end up paying between 15% to 30% in taxes from the sale of a property. By using this strategy, Texas investors can plan their real estate portfolio more and build their wealth.

If you are interested in a 1031 exchange then you should be aware of all the requirements

Property Requirements

To qualify for a 1031 exchange in Texas, there are certain rules to follow. The first rule is that the property must be utilized for business or considered as an investment. By this definition, personal homes are automatically excluded from the list. Vacation houses that aren’t used as rentals are also exempted from the category, as well as fixer-upper properties with an objective to be resold by the investor. Although vacation homes can qualify under certain conditions, you must seek legal expertise on this.

For a 1031 exchange to be successful, you must observe the following:

  1. Both properties must be used for investment
  2. Both properties must be considered as “like-kind”

Examples of qualified 1031 exchanges:

“Like-kind” properties can be broad in their meaning. You can swap real estate such as:

  • A ranch for an apartment complex
  • An office building for an apartment
  • An apartment for a shopping center
  • A shopping center for a farm
  • An industrial building for raw land

Types of Real Estate Exchanges

There are 4 types of 1031 exchanges you can do:

1. Delayed exchange

In this exchange, an investor is required to sell the property prior to purchasing a new property investment. This is more convenient to the investor since they don’t have to have a big financial reserve to buy a property and instead use the sales proceeds for the transaction.

The challenge in a delayed exchange is to find a buyer immediately and the exchange has to fit the 180-day period. There’s also a restriction of only 45 days to find a new property.

1031 exchanges in Texas require careful planning and navigation

2. Simultaneous exchange

In this exchange, it’s required that the buying and selling of the investment property occur on the same day. Otherwise, the transaction can be deemed as disqualified. Once this occurs, the investor cannot anymore defer the capital gains taxes resulting from the sale of the investment property.

There are 3 ways to fulfill the simultaneous exchange:

  • Three-party exchange with an “accommodating party”
  • Three-party exchange with a Qualified Intermediary
  • Swapping deeds with another real estate property owner

3. Construction or improvement exchange

In this exchange, the investor is allowed time to make improvements on an investment before the transaction takes place. The investor is granted 180 days to finish all the renovations.

There are 3 requirements to meet to defer the capital gains taxes:

  • The full equity of the exchange must be spent on all the construction costs to improve the property. It must be done within 180 days.
  • The value of the property must match in value or be greater than the previous original property once improvements are performed.
  • All the construction must be finished within the allotted 180-day period.

4. Reverse exchange

This exchange entails looking for a property to invest in before pushing through the sale of your current property. This means having enough capital to purchase the new property. Although this requires extra funds from the investors, the benefit is they can gain more time in selling the property in their hands. If the economy is performing well, then it also means that the investors can earn extra money derived from market appreciation of their present property.

It’s important to remember though that investors are restricted to having only 45 days to determine the property they want to sell. Another restriction is that the entire sales transaction must wrap up within a 135-days period.

Having professional assistance can help you benefit from a 1031 exchange in Texas

Important terms to remember in a 1031 Exchange

Like-kind property

To consider properties as like-kind, they don’t have to look similar. The exchange can involve exchanging raw lands with commercial centers and apartment complexes with office buildings. If both properties are in the US, then there can be a 1031 exchange as long as they meet particular conditions.

Investment property

Investment property comes down to business real estate in a 1031 exchange. This can refer to condo units, townhomes or shopping centers. As long as they’re not for personal use, they can be qualified for an exchange transaction.

Excluded property

Like-kind exchanges exempt personal properties such as cars, homes and private yachts. This also includes cash, stocks, bonds, notes and other securities counted as account receivables.

Boot

Boot is essentially a non-like kind property. It can represent cash, debt reduction or any form of personal property provided in a 1031 exchange. Receiving boot disqualifies you from a full tax-free 1031 exchange.

Same title holder

Basically, this means that the listed name on the property title of the soon-to-be-sold property and the acquired property must be one and the same.

Exchange period

An exchange period refers to the time given to finish the acquisition of a new like-kind property to exchange with the current property. The fixed exchange period is 180 calendar days. It’s non-extendable in observance of weekends or holidays.

Identification period

A set period to identify which property an investor chooses to replace for the like-kind exchange. The fixed identification period is 45 calendar days. It’s non-extendable in observance of weekends or holidays.

Conclusion

You can check out the IRS’s 1031 exchange fact sheet for more information. As an investor, you want to experience the full benefits that 1031 exchanges can offer. As much as 1031 exchanges can be advantageous as a strategy for investors in wealth-building, they require a lot of technical knowledge to execute legally. It’s advisable to consult with an expert to perform a 1031 exchange in Texas.

If you need assistance to successfully navigate a 1031 exchange in Texas, please contact Bigham & Associates at (512) 339-8812.