If you are new to a 1031 exchange, you may be unsure of the types of properties that can be swapped out as part of your transaction. 1031 exchange home purchases are allowed, but only as an investment property. The purchase is not supposed to be for personal use or living space. It is strictly an investment exchange.
A recent client of course suggested the purchase of a beach property for their 1031 exchange. While an oceanfront property sounds very tempting, it can only be considered for an exchange if it will be treated as a rental property.
The role of a 1031 exchange is to defer capital gains tax for an investment property that is being sold. As a result, the relinquisher must purchase a like-kind property within certain guidelines to ensure all criteria is met.
1031 Exchange Home Purchases
Throughout our experience, we have witnessed various 1031 exchange home purchases for numerous clients. While some investors prefer multi-family properties or commercial real estate investments, single family home options are always a choice for the investor.
Last year alone. JSG Realty transacted on a multitude of 1031 exchange home purchases. A client relinquished land in Rochester, New York. Within the timeframe criteria, they identified and purchased four different individual Apartments throughout the Country. Two properties were purchased in Los Angeles, one in Brooklyn and the other in Upstate New York. Since the purchases were of an all cash nature, our team structured a closing soon-after the contract signing. With the proof of funds prominently displayed, a contract deposit, which is typically required at contract signing was foregone. The transaction went straight to closing shortly after the contract was mutually executed and all funds were wired at closing.
According to the 1031 tax laws, property may be exchanged for like-kind investments. The rules are fairly relaxed and a multi-family investment property can be swapped for a commercial building or in the case above, land for 1031 exchange home purchases and single family Apartment investments.
The Importance of a QI
Most importantly, in order to property proceed with a 1031 exchange transaction, a purchaser must contract with a qualified intermediary to assist with the 1031 exchange. All funds from the relinquished sale must go directly into the QI account.
It is important to select an intermediary that is very qualified and has vast experience with these types of transactions. Do not select a 1031 qualified intermediary strictly based on budget. Experience and knowledge are the most important factors when choosing an exchange partner.
For a 1031 exchange, specifically 1031 exchange home purchases in this circumstance, a purchaser will have 45 days to identify a replacement property or home from the time the relinquished property is sold. The identification period moves very quickly and every 1031 exchange buyer should stay aggressive in identifying a property and signing a contract as quickly as possible.
Invaluable Rules for 1031 exchange home purchases
- Home Inspection – We recommend an inspection to be completed during the 45 day identification period to ensure the home is satisfactory. If the purchaser has the home inspected after the 45 day period and there is an issue with the property, they will lose a potential selection from the list and cannot replace it with a different property. In any sale, a home inspection is critical as it examines important criteria about home such as plumbing, heat, electricity and other specific items
- Rental Income Analysis – With the help of a qualified Real Estate Broker, an analysis should be created for projected rent of the investment property. This will help validate whether this home will generate a sufficient rate of return. It’s also important to consider whether a current tenant is paying below market rate and if the price can be increased with future renovations. Perhaps the addition of stainless steel appliances and granite countertops in the kitchen will allow for an increase in rent. Fully renovated homes or Apartments can attract more rent but the cost of the renovation must be factored in. An experienced Real Estate Broker should have a contact list of affordable and reliable vendors to help provide a quote on any repair work
- Appreciation – Finding a property that will appreciate in value is important. Make sure to review all of the comparable sales in the neighborhood and verify there is upside potential in this purchase. Savvy real estate investors prefer to purchase the most affordable and opportunistic property on the best block in town. If one can find this type of property, this is the golden type of 1031 exchange home purchases since the value should drastically rise at a later period in time. Buying an overpriced home on a bad block is the opposite scenario. An investor can also analyze a property by determining the price per square foot. This can be used as a comparison with other homes in the area. It is a smart way to rate and measure 1031 exchange home purchases in a given location
- Tax Analysis – Looking at recent tax increases in the community or surrounding neighborhoods is valuable information. A buyer should be certain the taxes will not drastically increase shortly after purchase. By analyzing the rates of increase or surrounding location data, this will help provide good information. Research can also be conducted to learn more about pending tax assessments. Some of this information is public knowledge and readily available to the purchaser. It is critical when deciphering 1031 exchange home purchases that may be of particular interest
- Zoning and Home Improvements – With the assistance of an architect, it may be wise to learn whether a home allows for additional square footage, an extra garage, pool in the backyard or other improvement. The goal for an investment property should always be to maximize the potential return and upside for the future. A seasoned real estate Broker will be able to provide a lengthy list of contacts in the industry, specifically an architect, zoning expert or expediter that can be valuable to your transaction decision
Get Your 1031 Ducks in a Row
Based on our expertise, we have witnessed 1031 exchange buyers make the mistake of conducting the above steps after the identification period is over. This can lead to a disaster for all parties involved. Buyers must conduct there due diligence in advance of the identification period deadline. If one of the properties is not carefully reviewed, but still identified, one cannot go back at a later time and change the identified property. This creates a shrinking pool of potential replacement properties with other buyers bidding for the same potential 1031 exchange home purchases.
Additionally, not only may the above mistake jeopardize a 1031 exchange, it will be a costly exercise for a buyer that is reviewing property that is no longer available. There will be an expense incurred to hire a home inspector or other professional for certain services. This is money that cannot be returned.
Therefore, it is critical to have all your ducks in a row and stay very organized with your 1031 exchange. Selecting an experienced 1031 real estate service provider is key to any transaction.
As dedicated Brokers assisting clients with 1031 exchange home purchases, we often create charts, spreadsheets, brochures, documents and other valuable content to help our clients make the correct selection with their investment. The type of asset acquired is subjective, but its critical to make certain the buyer is comfortable and at ease with the purchase. This will hopefully be a controllable asset in their portfolio for many years to come.
Keep in mind that 1031 exchange home purchases or individual Apartment investments will require some form of property management or maintenance on the home. It is inevitable that the boiler will need maintenance, roof may need to be replaced, plumber or electrician will be called to the home or some other form of improvement. However, if this is factored into your pro-forma and financial projections, this should alleviate concern. Erring on the side of caution and planning for the unexpected is important with an budgetary creation, especially with 1031 exchange home purchases.
When it comes to a 1031 exchange, specifically 1031 exchange home purchasers, buyers must be aware of all the circumstances and future events post-purchase that may unfold.
At JSG Realty, our goal is to provide outstanding customer service and walk clients through every step of the 1031 exchange process. This is a significant purchase and outlay of money. 1031 exchange home purchases are not to be taken lightly and we will provide our greatest expertise to dedicated clients, investors and 1031 exchange home purchasers.