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The Advantages of a 1031 Exchange

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What is a 1031 Exchange?

A 1031 exchange is an IRS term for swapping one income property for another. It is a unique tax benefit that is becoming increasingly popular in real estate deals as property owners look to trade up for vacation homes that they intend on renting out to guests. In the eyes of the IRS, you’re changing your investment from a relinquished property to a newer property while allowing your investment to grow, tax-deferred. You will defer paying taxes on the sale until you sell many years later if you qualify for a 1031 exchange.

What qualifies as a 1031 exchange?

Only investment properties or properties used for business are eligible for 1031 exchanges. This includes apartment buildings, vacant lots, commercial properties, or residences you rent out to tenants. However, a property you have solely for personal use does not qualify, such as your primary residence.

Can I buy a vacation home with a 1031 exchange?

Using the proceeds from the sale of an investment property into a vacation home allows you to increase the value of your investment while acquiring property that you can enjoy. As long as you rent out the property for more than 14 days per year and use it personally for fewer than 14 days per year with no more than 10% of the nights rented (within the first two 12 month periods after the exchange) – you can invest the proceeds of the exchange into a vacation rental home.

What are 1031 exchange rules?

The 1031 exchanges come with several rules that you must abide by. We always recommend consulting with a lawyer, CPA, or tax advisor to determine if a 1031 is the right decision for you and your property. However, we have summarized below the general rules of a 1031.

  • The investment property that is being sold must be similar or like-kind to the property being acquired.
  • 1031 exchanges do NOT apply to personal property.
  • The newer replacement property must be of equal or greater value than the previous investment property.
  • Partial exchanges of a newer but less valuable property are an option; however, you will have to pay the usual capital gains tax liabilities on the difference (also known as “the boot”). For a 1031 to be completely tax-free, you cannot receive “the boot”.
  • The titleholders and tax returns of the old and new properties must remain the same.
  • After closing, you will have 45 days to identify up to 3 potential similar/like-kind properties as a replacement.
  • Your replacement property must be received and exchanged within 180 days after your original property is sold.

What are the advantages of a 1031 exchange for vacation rentals?

There are many advantages to a 1031 exchange for vacation rentals, and Global can help you maximize these benefits. Below are some of the most significant advantages:

Earn “free” nights while working on your home:

Do you have plans to improve your home or simply enjoy performing DIY projects around the house? Days spent working on your vacation rental property do not count against your 14-day stay limit. That means you can stay in your home whenever you like as long as you put in some work to increase its value.

You can continue to do 1031 exchanges:

Currently, there are no limits to how many times you can conduct a 1031 exchange. You can keep rolling over the capital gains from one investment property to another. Even if each exchange produces a profit, you can defer paying taxes until you sell for cash.

Eventually, you can stay as often as you’d like:

After two years of your personal use being limited to 14 nights per year and renting it out to guests for 10x as much as you stay there, you are free to stay for as many nights as you wish without further requirements. However, if you continue to rent out your home for at least 14 days a year, you may be eligible to write off most of your rental expenses to reduce your taxes.

Are you interested in knowing more?

If you are interested in finding more about 1031 exchanges, please do not hesitate to contact Global today. As experts in the industry, we are happy to use our knowledge and experiences to guide you towards the best decision for you.


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