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What is a 1031 exchange? 👀🤓

If you're starting to get involved in the real estate world, you may hear people talk about doing a 1031 exchange. Now what in the world is that and why would you use it? Keep reading, I'll explain!

Essentially, a 1031 exchange allows a property owner to defer their capital gains taxes. Short term capital gains tax (which is very common for investors) is applied if you own a property for less than a year and it is based on your income ratio as seen below:

The way a 1031 exchange works is it allows you to swap one investment property for another in order to avoid the capital gains tax. There are a few caveats to this process.

  1. The property must be a like-kind (i.e you can’t sell a $150k house and buy a Ferrari).

  2. Must be swapped for business or investment properties and it must be of equal or greater value.

  3. There is a time frame on 1031’s. It's the 45-day rule (once you sell a property you have 45 days to find a replacement. You can identify up to three properties you're interested in, but you only have to close one of them)

  4. Candidate homes must not be greater than 200% of the value or less than 95% of the value.

It's worth mentioning that it is also possible to purchase a home of lesser value, but you will have to pay taxes on the profit of the sale that you did not use to purchase the new home.

This process can seem daunting since it involves the IRS and taxes, but it is fairly simple and there are plenty of companies that will organize the entire transaction for a fee. I used a company called IPX 1031 for my first one. They charged a fee of about $750, but I didn't have to worry about doing any documentation correctly and felt they assisted with keeping me within my timeframe along the way.

Overall, a 1031 exchange can be very beneficial when selling a property you haven't owned for a long time and allows for the ability to purchase a larger project without incurring the fees. Hope this was helpful information! Happy investing!

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