An effective 1031 Exchange allows a real estate investor to retain all capital gains from their relinquished property and reinvest in a new property. In effect, of rules of a 1031 Exchange, the deferred tax can be utilized by the investor and considered an interest-free loan from the government.
The more dollars you invest in a property, the greater potential cash flow you will get and observe an increase in its value over time. Internal Revenue Code 1031 Exchange’s main motive is to help bridge the gap between real estate investments and lifestyle and fashion objectives by allowing investors to reposition and exchange their investment property while deferring capital gains tax. While making an exchange under 1031 Exchanges rules, one must ensure that acquiring the new exchanged property is of the same kind and has the same capital value.
The 1031 Exchange Property Identification Rules
To acquire a valid property under 1031 Exchange, identify a legal property that falls under IRS rules and comply with all conditions. You must follow these three important ground rules:
- The Three Property Rule: The exchanger can identify up to a maximum of three replacement properties, regardless of their values.
- 200% Rule: While identifying the property, the exchanger must shortlist its options with an equal value or aggregate value of the property, not exceeding 200% of the value of the relinquished property.
- 95% Rule: The exchanger must ensure that his exchange option must not exceed 95% of the replacement properties’ aggregate value.
Who is a Qualified Intermediary?
A Qualified Intermediary (QI) is your professional agent, real estate broker, or financial attorney who will hold onto your funds until the exchange proceeds. Simultaneously when the replacement properties are identified, the QI releases your funds to acquire the replaced property. Neither of your blood relatives, parents, children, or siblings can act as a Qualified Intermediary. The renowned Federation of Exchange Accommodators (FEA) would help you find a Qualified Intermediary who helps you throughout the entire 1031 Exchange process.
Why Invest in Real Estate?
With the ongoing increase in population and demand for land, the real estate business is flourishing. Real estate investments generate temporary bonus incomes, which is the rent paid by tenants occupying your property. If you are looking for tax exemptions in your business or investment, real estate is a secure, well-monitored, and safe investment. During the inevitable inflation hedge, the real estate business has served as an effective hedge to combat inflation. The underlying property capital gains and their values have kept pace and exceeded the rate of inflation. Depreciation benefits are always a silver lining for real estate investments, as real estate property values never depreciate; in fact, their value and importance grow with time.
The real estate market has shown phenomenal growth and development, encouraging investors to invest in real estate. And, section 1031 Exchange helps them replace their properties as per their need and interest. With the ongoing investment in real estate, you can get tax exemptions, which will help you maintain a steady cash flow and make profits.