Questions & Answers

Note: A 1031 Exchange is an IRS section that only applies to investment properties.

Q. What, exactly, is a 1031 tax-deferred exchange?

A. Let’s begin with a standard transaction and then illustrate the difference. When an income property is sold for a profit, that profit is considered taxable income to the IRS. You pay tax only on the actual profit. The tax you would otherwise have to pay is called “capital gains tax.” In most cases, particularly in California, if you held the property for more than a few years, that profit and tax is considerable.
The 1031 Exchange enables you to avoid paying capital gains tax on the sale of your existing investment property when you use the money to purchase your next investment property if certain rules and procedures are followed. But don’t worry. We’ll make sure you are walked through the entire process with all your tax and legal questions answered by the appropriate professionals. We make it easy.

Q. How can I do the 1031 Exchange and avoid the tax?

A. The tax is deferred or postponed until you eventually sell a property outright to obtain the profit from your transactions. Think of it as being able to put untaxed, earned money in a retirement account. Because the money is not taxed on the way in, you have more to save in an interest-bearing account. When you finally withdraw the money in the future, that’s when you pay the tax. Investing untaxed money allows higher numbers to grow faster.
To simplify the comparison to real estate, let’s say you purchased a property with cash a few years ago. Now you want to sell and use the money to buy another property. If you had to pay tax on the property’s increase in value (profit), you would have less to invest in your next property. The “exchange” bypasses the taxation because in the eyes of the IRS you never really sold the property. You see, in the exchange, you never take possession of the money from the sale. It is held for you by a third party called a “qualified intermediary” (QI). When you purchase the next property, the QI puts that money into the escrow for the purchase. This procedure makes it so that you don’t have to pay income tax on your last sale.

Q. What is a Qualified Intermediary (QI), exactly?

A. It is an independent party, qualified by the IRS, whose job it is to facilitate 1031 Exchanges. The QI holds the money from your sale so that you don’t actually come into possession of the funds. The IRS will not allow you to simply put the money into your own dedicated bank account for use in the exchange. During the purchase of your replacement property, the QI transfers the funds from your sale into escrow to complete your purchase. Of course, this must all be done within appropriate time limits, etc.

Q. How can I find the right Qualified Intermediary; are some better than others?

A. We will introduce you to the right Qualified Intermediary. After years of being involved with 1031 Exchanges, Jim Carvin believes we have found the best. He only uses time-proven trusted advisors in his real estate transactions and never gives unqualified advice. Let’s illustrate a comparison.
Most QI’s do nothing but hold money during a transaction while making sure that no rules are broken. They do not give any tax or legal advice because they are not qualified to do so. Instead, whenever you have a tax or legal question, they require you to hire a lawyer or CPA to answer your questions and advise you. The Qualified Intermediary that we use is a firm that is operated by CPA and a lawyer. They are a great team and are qualified to answer all your tax, legal and procedural questions during the transaction.

Q. When should I decide whether I want to do a 1031 Exchange?

A. Planning ahead is always best. When you list your property for sale with us, we inform the real estate community of buyer’s agents that a 1031 Exchange is intended. This is done within the actual listing in the Multiple Listing Service (MLS). If buyer’s agents should know from the start. Informing buyers that they must “cooperate” with a 1031 Exchange after an offer is made may cause a buyer to cancel an offer. It would certainly start the whole dance off “on the wrong foot.” A 1031 Exchange can be disqualified if you wait too long to start the procedure.

Q. What are some of the rules we must follow to complete the exchange without being taxed?

A. There are several rules and scenarios possible in an exchange. The time constraint is the most basic, which we’ll cover here, according to the most typical “3-Property Rule” scenario. Other scenarios that may apply to your own unique situation can be covered in a personal consultation that can be setup by contacting Jim Carvin.
You have 45 days after closing the sale of your investment property to identify only 3 potential replacement properties. You must complete the sale on one of those specifically identified properties within 180 days after closing on the property you sold. Buying one of 3 specific properties within 45 days might not seem like a big challenge. However, even in a normal real estate market it can prove impossible due to several factors. The IRS allows no extensions except in cases of extreme natural disasters.

Q. I understand that if my 1031 Exchange fails for any reason that my money will be taxed! What can I do to avoid a 1031 failure?

A. First, begin by listing your property for sale with Jim Carvin so that there is time to make things happen when they should. Second, the most common cause of disqualified 1031’s is failure to close on one of the 3 selected replacement properties. You will need to make sure your offer on one of those properties is accepted and can close within 45 days of closing your existing property. It takes most lenders 30-45 days to close a deal, so you’ll want to have an offer accepted and be in the second escrow before your existing property closes. If you are an “accredited investor,” you may create a beautiful safety net in case of failure. See the next question.

Q. I’ve had my share of rentals and I’m sick and tired of being a landlord!! I want to cash out and even putting the money into a ridiculous bank account would be better than getting taxed. But only real estate qualifies for a 1031 Exchange, and I still want my money to be in real estate. Do you have any brilliant ideas about what I can do?

A. Yes, there is a solution that provides qualified investors with a 1031 Exchange-qualified real estate investment that is passive and hands-off. To find out more and to see if you qualify, CLICK HERE.