What is a 1031 Exchange, and how can it help you?

When it comes to owning rental properties in America, investors are incentivized to upgrade without having to pay the capital gains taxes that come with closing a sale. The IRS created a rule called “the 1031 Exchange” to motivate rental property investors to take that money they’d owe on taxes and put it into another rental property. There are a few rules and regulations, of course, but the 1031 Exchange can be a great opportunity to grow your wealth. 

For starters, this IRS rule only applies to rental properties (sorry, house-flippers, this exchange won’t help you!), but you can get creative about what kind of property you want to invest in. From office buildings to single-family homes, the 1031 Exchange applies to all rental properties. If you’re ready to reinvest your rental earnings, make sure you note these three factors:

1. During the sale of your original rental, you must pick a third-party “qualified intermediary”(QI) to facilitate the process. Once you’ve sold the property, all proceeds will be transferred to the QI to hold onto until the purchase of the next property. If you use any piece of those earnings for something other than that transaction, the 1031 Exchange will become void. 

2. You have just 45 days after closing to identify one or more property to exchange—be sure to have back-up options in case one falls through. You must then close on a property within 180 days. 

3. Your replacement property must fit a certain criteria to meet the standards of the 1031 Exchange. It must be an income-producing real estate property with a value equal to or greater than the value of your original property. It must be an investment property, not a personal residence. It must also be within the borders of the United States. 

1031 Exchanges can be a powerful way to grow your real estate portfolio, as long as you follow the rules above carefully. What’s more, when you become a PadSplit Host, you can boost your residential properties’ earnings by leveraging underutilized space, while gaining access to a steady stream of tenants.