Do you know that feeling when you have to rush to the mall because you forgot to buy your partner a gift and it’s the eve (or eves) of? Panic rushes over you and you think ‘Oh my goodness what am I going to get?! Why did I ever wait this long?! Is there going to be anything left on the shelf?!’ That is exactly what you want to avoid… the thought of, ‘well it’s going to have to be good enough because it’s the best I can do at this point’.
Let’s go back 180 days to when you closed escrow on your income property. Some broker had told you of a way that you could avoid capital gains tax by buying another property? That’s where the first common misconception needs to be cleared. A 1031 exchange is a tax deferred exchange. Meaning that when you sell your income property, instead of paying capital gains tax on that sale, you can exchange and all your prior equity and gained income for a ‘like-kind’ property. It’s not that the taxation goes away, but instead you kick the can further down the road to when you sell your new 1031 property.
So back to the timeline. You sell your property and closed escrow, but instead of collecting your money, you had to have found a Qualified Intermediary (QI) who holds your capital in a separate account so that you CANNOT access it. The second you touch those funds, is the second you are taxed on them. So, make sure you pick a company who is well recognized, because it never really feels good when someone else is holding your wallet. There are plenty out there and even some title companies have their own intermediaries so do don’t be afraid to do some research and look for someone with experience, Intersection’s team of experienced commercial real estate advisors are happy to help!
After your property closes escrow, you have 45 days to identify three like kind properties. Those properties must be at a cost high enough where it replaces the entire equity amount and your gains- because hopefully you made money on your sale, right? If that list includes a price of a new property that only partially accounts for the new equity amount, then that’s okay! But make sure another property on that list covers the rest- and be sure with the partial equity amount you still qualify for a loan for both properties, if needed. Otherwise known as spreading yourself too thin. Don’t do that!
This is where the panic might begin. This is crunch time. If you do not identify three possible new properties to purchase in 45 days, then your money will be returned to you and you will be taxed on it. Done. The End. You identifying properties does not mean you climbed a mountain and shouted from the top the three new addresses. What it means is that you spoke to your QI, filled out the proper IRC Section 1031 Exchange form and it was all filed by the 45th day after the sale of your property.
The reason as to why this is where the panic happens is because if not played correctly, the three properties can fall through, and you might have to identify something that you might not have originally wanted! Maybe it didn’t have as high of a return as you were looking for, maybe it is outdated and needs repairs, who knows?! The fact of the matter is; don’t wait until the last minute, when the shelves are bare! You don’t ever want to settle, right?! That said, this is where the hunt for an exchange property should have already been in place.
There are many routes to take to make sure you don’t settle for less than you deserve. What we find to be best is; before your escrow closes, you are already under contract to acquire a replacement property. You heard me right! The ideal time to start would be before the buyer of your property is under contract. That is how far along the process you should ideally be. It takes a little extra time and planning up-front, but trust us when we say, it’s well worth it, to not have to panic as your deadline closes in.
It might seem like a complicated process, but it’s only as complicated as you make it. You have deadline’s you must keep, but get your shopping done early and avoid that panic. It’s never worth the stress, or the risk of having to settle.