Looking to sell your investment property in Seattle, Washington? You should consider making use of a 1031 exchange.
One famous quote repeated time and time again timelessly holds true: “There are only two things certain in life—death and taxes.” As a property owner, you can relate to this statement, paying taxes and fees on a periodic basis.
Selling your Seattle investment property as a property owner will rack up a combination of several state and federal taxes. However, one option exists whereby you can avoid capital gain taxes on your Seattle property.
This window of opportunity was granted to investment property owners by Section 1031 of the Internal Revenue Code (IRC). It allows proprietors of this class of property to defer taxes, given that certain provisions have been met. 1031 exchanges are also known as like-kind exchanges or starker exchanges.
Provisions and Conditions by the IRS
The proceeds of selling of the investment property must be reinvested in a similar class of property. A common question among property owners and developers is whether flipped properties meet this threshold.
The answer is no. The rules under section 1031 clearly prohibit the inclusion of properties bought for the purposes of resale. For such a property, you will have to meet the full state and federal taxes.
As stated above, a 1031 exchange is also known as a like-kind exchange. The term though needs some deeper interpretation. The definition of investment property has been expanded to involve properties that are being used for trade or other business needs.
That said, you can exchange an office building for a farm. Using the interpretation above, you can see that both properties are used for trade purposes. The term “like-kind” allows for a number of interesting combinations.
The benefits of the exchange do not apply to buyers and sellers of personal homes. Vacation homes are also included herein, since they are used for personal use.
The use of a property might be unique and not be mentioned in the provisions given above. We recommend that you consult a reputable tax specialist who can advise you accordingly.
The Types of 1031 Exchange
Simultaneous 1031 Exchange
This is one that occurs on the same day. The investor relinquishes his property and closes on the replacement property concurrently. Prior research had to be done on possible replacements.
Delayed 1031 Exchange
As a property owner, you would want your new property to have similar amenities or provide similar utility to the previous one, if not better. Once sold, the investor searches studiously for the replacement. It is the most common type.
Reverse 1031 Exchange
For this one, a bank or financial institution is involved. The property will be bought first, and the monies repaid after the transfer goes through. Investment properties typically have higher risk than normal and as a result, most institutions won’t touch such an option.
The Timing of the Exchange
After you have sold off your investment real estate, Section 1031 of the IRC gives you 45 calendar days to identify three possible replacement properties. It goes without saying that the replacement properties must be like-kind. The 45 days is also inclusive of weekends and holidays.
Failure to stick within the prescribed time limit means that your exchange will be disqualified. Once disqualified, the tax benefits will be declared null and void. Corresponding taxes, therefore, have to be paid.
Once you have narrowed it down, the exchange must be completed either within 180 calendar days or before the due date for the tax year in which the previous property was sold; whichever comes earlier. The count of the 180 days starts from the day you transfer your property to the buyer.
The Role of a Qualified Intermediary
The IRS Rules necessitate that a 1031 exchange must be carried out with the help of a Qualified Intermediary (QI). Section 1031 specifies that a family member cannot serve as your QI and neither can someone who qualifies as your ‘agent.’ This includes your real estate agent, broker or attorney.
The QI plays a critical role in the exchange. It is the QI’s duty to hold the proceedings for the sale, purchase the replacement property and transfer the title to you. There are a number of legal complexities to be handled.
It is recommended to choose a professional Qualified Intermediary. Errors and omissions, whether in regard to the deadlines or other provisions, will result in payment of taxes to both the state and the county.
During the transfer of the like-kind property, the buyer may receive money or other receivables that are not like-kind in nature. Such additions are recognized and allowed for in a 1031 exchange. The technical term is ‘boot.’ Other sources of boot also include mortgage reduction, property tax proration and the use of sale proceeds for invalid closing costs.
It is only the property that is considered tax-free. The boot will automatically be taxed. Therefore, it is always recommended for the investor to trade up. Trading down will automatically result in certain receivables, negating the tax-free nature of the 1031 exchange.
The 1031 exchange should go through successfully and as a property investor, you will have experienced no gains or losses. The last item to go through is the reporting of the exchange. You will require a Form 8824 for this.
If there is a boot involved, it will also need to be reported. Depending on the type of the boot, you will need a Form 8949, Form 4797 or Schedule D (Form 1040).
Conclusion: Everything You Need to Know About the 1031 Exchange
A number of real estate investors are making use of the 1031 exchange. Throughout the years, it has proved to be a highly efficient tool for legally deferring taxes.
If you are selling an investment property in Seattle, you may want to consider the advantages of a 1031 exchange. You can reach out to us at T-Square Properties, as we are experienced real estate providers who can help. Our expertise and experience may prove crucial as you traverse the technical, but profitable conditions of the exchange.