Before starting your 1031 exchange, there are a few questions you’ll want to consider before selling your investment property and entering into a 1031. Below are questions and considerations we discuss with new clients about their investment property to see if a 1031 exchange will work for them.
- Why do I want to do a 1031 Exchange?
It’s important to consider why you might want to do a 1031 Exchange, so you know you are doing it for the right reasons. Maybe you are an investor looking to build your portfolio, or maybe your current investment property isn’t meeting your goals and you’d like to reinvest in another property instead. Often, we see folks who own and rent out their vacation homes, and are simply looking to sell and reinvest in another vacation home and used the money they have saved by deferring taxes to add some improvements or purchase new furniture. Occasionally, we also see investors looking to do an exchange for a home with the intention of converting it into their primary residence a few years down the road. If you’re doing a 1031 exchange with hopes of using exchanges in a series of quick fix and flips, you may want to reconsider if a 1031 is the best for your investment goals.
- Does my property qualify for a 1031 Exchange?
To determine if your property qualifies for a 1031 exchange, you need to consider how you’ve used it. If it is held for investment, or income producing—such as a commercial building or a rental home—then your property will qualify for a 1031 exchange. Another property that always qualifies as being held for investment in a 1031 is land. A property such as a primary residence or a vacation home that has never been rented to tenants would not be considered income producing, and therefore would be riskier in a 1031 exchange. What the IRS is really looking at is intent—did you intend to use this property for investment purposes? If that’s the case and you can show that, a 1031 could still be a good option for you. There are no exact guidelines given by the IRS as to what qualifies as for investment (with the exception of Safe Harbor Safe Harbor for 1031 Exchanges, if you choose to go that route), so that intent is critical if the IRS were to ever audit your 1031 exchange. If you are unsure if you have enough proof of intent for investment, give us a call or speak to your CPA. You can read more about dwelling’s being held for investment here Vacation Homes and 1031 Exchange
Something else to consider is how long you have held onto your property for. Again, this is something that the IRS does not define in section 1031. Typically, we recommend that you hold title to your property for at least a year and a day, to show long term gain. Any amount of time shorter than a year and a day may be questionable to the IRS, as it would be considered short term gain and could appear that your property wasn’t intended to be held for investment. We always say it's best to play it safe! If you are unsure if your property qualifies for a 1031 exchange, gives us a call and we’d be happy to speak with you to help determine if your property qualifies.
- Is it financially worth doing a 1031 Exchange on my investment property?
This is a question we recommend you speak to your CPA or accountant about. With them, you could take a closer look at your previous tax returns to determine if doing a 1031 Exchange would be most beneficial for you.
- Once I sell my investment property, what do I need to consider when buying the replacement property?
When preparing to do a 1031 exchange, you want to also prepare yourself for what to expect when the time comes to purchase your replacement property. Please go to Buying Investment Property in 1031 Exchange to read about what to consider when purchasing your replacement property.
If you are considering selling your investment property in a 1031, we’d love to have these conversations with you. Please gives us a call, and we will consult with you about the possibility of doing a 1031 exchange.