How Long Do You Have to Hold Property After a 1031 Exchange?
If you are wondering what realty investment shows the most profitable in 2022, the 1031 exchange is out of competition. People call it a perfect tax deferral strategy, and it is totally justified. It denotes that you may trade properties for one or a few other buildings in different areas to choose from without paying federal income taxes while swapping.
So this article will cover everything related to 1031 exchanges, including timing limits and how you can benefit from a NNN lease in this case. Read on to find valuable info for you.
The Notion of a 1031 Exchange
According to 1031 exchanges, owners of possessions may swap them for like-kind ones. Typically, the replaced property is of equal or more expensive value. While property exchanging, any capital growth you usually get passes to the next possession. That way, you won’t need to pay taxes until the replacement property comes to sell.
Some people interpret a 1031 exchange as a tax loophole, which is entirely wrong. Of course, it puts a substantial economic incentive since you are allowed to defer taxes for a while. But it doesn’t mean you can avoid them forever. Be sure the time to pay will set in anyway.
In addition to obvious financial perks, this exchange type lets you move your investments from buildings in one location to another area across the country with no IRS-connected issues. Plus, shifting from high to low property maintenance is effortless and without a heavy tax hit.
Why Opt for a 1031 Exchange
Capital gains taxes deferment
No doubt, it stands as the sweetest advantage. Due to this, the investor can make a bigger initial payment than in other cases. Thus, growing wealth and building a good investment portfolio are more real than ever.
Trouble-free investments move
You might minimize portfolio risks significantly due to swift and easy investment transfer. For example, owners can change possessions that need plenty of practical upkeep, like a brief-terms rental, to buildings that don’t require so much direct involvement.
Estate goals planning enhancement
Commonly, 1031 exchanges are about tax deferring, not avoidance. However, when an investor buys a 1031 exchange property and then passes away, the assigned heir won’t be responsible for deferred taxes, and they will be simply voided. So the heir will get possession at an increased market price rate and must not pay the deferred tax sum. A realty planner may give you a clear vision of how to turn this strategy in your favor.
A 1031 Exchange Types with Timelines of Property Hold
To get a complete insight into how a 1031 exchange operates, it is worth checking its basic four types. How long do you have to hold property after a 1031 exchange? We will also consider this in view of each exchange type.
1. Delayed 1031 Exchange
Being the hottest agreement among Americans, it offers investors the most lasting timeframe to complete the exchange. In compliance with it, investors can first organize the initial property selling and then purchase the replacement building.
So it works as follows. First, the owner must put up the possession for sale, find a purchaser, agree on a purchase deal and finally perform a sale. And all these actions are to carry out even before starting the delayed exchange. After that, the investor is liable for engaging a skilled third-party intermediary. The expert then holds the sale funds for 180 days until the investor selects and possesses a like-kind realty for the exchange completion.
According to this exchange type, the owner must find a building to replace within 45 days and fully swap in 180 days. The delayed 1031 exchange timeline is rigorous. So when you don’t adhere to them, the agreement may fail a favorable tax policy. Such a tax treatment means eliminating pressure on the deal and allowing investors to sell while the realty market is profitable. Plus, they can spend some time picking the best-fitting properties for replacement.
2. Reverse 1031 Exchange
This deal provides completely opposite order from the previous one. With this exchange, owners have to purchase a replacement building primarily and sell their original properties subsequently.
Still, at first glance, a pretty simple reverse exchange might be highly challenging to put into practice. This is because the owner must use all cash for the buy, and a vast array of banks do not ensure loans for forward exchanges. So when the investor does not close the refused realty in 180 days after acquiring the replacement real estate, the exchange will not meet the requirements. As a result, you may get federal income taxes to pay off.
3. Simultaneous 1031 Exchange
As the name implies, this agreement calls for simultaneously closing both refused and replacement properties. So it is better to take care of each step’s timeliness. Since even minor delays with money transfers or other moments across the deal might lead to the exchange disqualification, ending in federal income taxation.
There are three varied scenarios for conducting a simultaneous exchange. The simplest way is a two-party switch between the possessors of the two buildings. Next, it goes an agreement involving an accommodating third party. Lastly, it is possible to exchange through a proficient intermediary.
4. Construction 1031 Exchange
Subject to this deal, investors can make improvements on the realty to replace and use the capital from selling the refused property. The skilled intermediary holds the realty deed in trust within 180 days. This exchange type needs the following three requirements to get met:
The whole capital amount is to spend as initial payments for enhancements on completed buildings by the 180th day from the exchange launching.
You have to acquire a like-kind property that you decided on the 45th day as your original property to replace.
The replacement realty must be of the same or more substantial value when the owner attains the deed from the intermediary back in 180 days. It would be best if you had improvements done before receiving the deed.
NNN Lease and 1031 Exchanges
When people start seeking realty options to invest within a 1031 exchange frame, diverse triple-net lease choices enter the arena. For those searching for a beneficial property investment, the type of lease is decisive.
Many like-kind swaps include investment buildings like office premises, apartment complexes, shopping malls or industrial realty. For sellers who strive to take advantage of the tax deferring and long for decreased property upkeep liabilities, a NNN lease is just the thing. Since if investors resort to 1031 exchanges while purchasing net leased properties, they might reach both goals.
However, to fully luxuriate in the NNN lease and 1031 exchange potential, you need to study the essence of NNN leases and their driven benefits in detail.
NNN Lease Essence and its Advantages
A triple net lease stands for a commercial agreement related to real estate rentals. With this deal, lessees must pay extra costs like realty taxes, realty insurance, and construction maintenance expenses besides the assigned rent fee.
While looking for properties to swap within the 1031 exchanges framework, familiarizing yourself with triple-net lease benefits is critical. It will help you go right with the realty choice.
1. Limited Management
From the investor perspective, the NNN lease is a paradise agreement as it gives the opportunity to enjoy minimal involvement in the property’s management process. Lessees take care of all the additional building costs apart from the usual rent, so you can say that lessors do not have any worries. Actually, the only thing they have to control is bookkeeping issues. So it is more than beneficial for busy investors working full-time jobs because they lack headaches with the typical upkeep duties.
2. Cash Flow Stability
One more appealing pro concerns stable cash income. Depending on the lease, there is a diversity of rental timing, but commonly, it lasts at least ten years. That way, lessors have a warranty of a positive passive gain during this time. Moreover, they do not need to search for new lessees yearly and worry about vacant areas for months.
3. Low-Entry Pricing
NNN leased properties’ entry price is typically quite affordable compared to other deals. Thus, you will considerably save by multiplying such an advantage on 1031 exchange opportunities. Indeed, you may come across prices on this realty starting from $500 000. So even if you are on a tight budget, you can still purchase a building at an accessible rate, obtain a lessee and begin earning the invested money back relatively quickly.
4. Expenses Rise Protection
Frankly speaking, many investors are guided by this pro when investing in triple net realty. Since the upkeeping and operating costs on properties are the responsibilities of renters, any of the expenses rise do not apply to owners at all. More precisely, if your building taxes or CAM grows, you will not be on the hook for paying the bills. Instead, your lessees will cover expenses, whatever the amount.
Last but not least, an attractive benefit goes for the ability to transfer leases between owners. It denotes that properties might trade hands a few times. So you can buy the building with a lasting lease, have stable cash gain for a while, and effortlessly transfer it to the other owner as needed.
Realized vs Recognized Gain in 1031 Exchange