When you are ready to sell your property, what matters most is the price and the proceeds you want to get from the sale. As interest for your property starts to come in, you are hoping for a qualified buyer who is ready to buy, but what if you receive an offer from a buyer who is doing a 1031 exchange?
Well, it’s a strategy for investors and a great benefit to a Seller. You just need to know how a 1031 Exchange works and what to look for to assess the buyer’s qualifications.
What is a 1031 Exchange?
When a property is sold, the Seller must pay capital gains tax on the Seller’s Net Proceeds – the profit that is the appreciated increase of value from when it was first sold. If you are the Seller and you purchased your property for $500,000 and then sold it for $1,000,000, you’d pay capital gains tax on the $500,000 increase in appreciation.
A Strategy for Investors
When an investor chooses a 1031 Exchange sale, they are taking advantage of tax deferral (postponement) of the capital gains tax on their proceeds. The federal government allows investors to defer capital gains tax if they put the proceeds from the sale directly into another property.
The other property must be “like-kind.” Which according to the IRS, means “when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type.” The exchange property cannot be a personal residence – it’s serving a “like” purpose as the property that was sold.
In addition, the Investor must identify the exchange property in 45 days from the time their property is sold. This can be a challenging hurdle because the investor is looking for a property that also meets their investment criteria, Fortunately, that can easily be addressed with implementing a 1031 Exchange Sale Strategy, which is what I help my investors do.
Another rule of the 1031 Exchange is that the Investor must close the purchase transaction for the exchange property in 180 days. While residential property sales can close in as little as 30 days, this 180-day rule is a hurdle in commercial real estate transactions, which typically have no less than a 60-day close and can take as long as 6 months or more to close.
Bottom line for the Investor – they need to move quickly in finding and closing on the exchange property!
Is a 1031 Buyer a Good Buyer for Sellers?
As a Seller, you want a qualified buyer: you want them to be credit-worth, you want them to be pre-approved, and you want to know they are in a position to meet all financial obligations of the contract. Understanding the 1031 Exchange Buyer is one thing. You also want to ensure you include specific terms in your counter offer to ensure the success of the 1031 Exchange:
- Specify that there won’t be an additional cost to you for the 1031 exchange and all costs related to the 1031 Exchange are the responsibility of the buyer.
- If your buyer has not yet sold their property, specify that upon the closed sale of their original property, the buyer is not allowed to hold the funds to purchase your property themselves
- Then include a term that the buyer must hire a third-party qualified intermediary to hold the funds, and the third-party qualified intermediary will transfer the funds to escrow to close the sale.
More Benefits to Sellers…
If you want to execute a 1031 Exchange for your own sale, you will follow the same rules as above, and you’ll need to hire a qualified intermediary to hold the funds for your exchange. It is best to create a 1031 Exchange Sale Strategy so you can meet the 45-Day and 180-Day requirements.