2022 has opened new opportunities in the real estate market, and most investors prefer starting the property business with 1031 exchanges. A 1031 exchange allows you to trade one or several properties in other developing parts of the country without paying or attracting federal income tax.
Simply put, you can defer capital gains tax on a sold real estate property through 1031 exchanges.
This article provides a comprehensive guide to the 1031 exchange rules for 2022, including how the 1031 exchange timeline and identification rules work.
What Is 1031 Exchange?
A 1031 exchange allows property investors to legally skip the payment of federal taxes that follows the sale of an investment property. If you are new to the real estate market, it is best to check 1031 exchange timeline and rules on the IRS website for additional information on how this exchange can affect your business.
One of the main advantages of a 1031 exchange is that it allows investors to move their properties from one part of the country to another without dealing with the IRS. Investors can also switch their investment options from high-maintenance to low-maintenance properties without incurring heavy federal taxes.
Furthermore, as long as investors continue to buy like-kind properties using the profits from the property sale, they can continue to swap numerous properties without paying federal taxes. The term “like-kind” refers to the nature and not the quality of the property.
Did the 1031 Exchange Rule Change
When this rule was newly introduced, investors were allowed to use 1031 exchanges to swap personal properties, intangible properties, and investment properties. So, investors could swap items like vehicles and artworks without incurring federal taxes. However, the 1031 exchange rules for 2022 limits investors to investment properties only. This change was first implemented in January 2018, under the tax cuts and jobs act.
1031 Exchange Rules and Requirements
There are five primary rules governing how 1031 exchanges work. They include:
- The Property Must Be Like-Kind
The properties to be relinquished and acquired must be like-kind. That is, they must share a similar nature or character. Note that investors can exchange one like-kind property with another in the real estate market.
For example, you can swap rental vacation homes for other rental properties such as duplex, apartment buildings, restaurant spaces, and other similar assets. Note that there are certain rules in place that govern how a 1031 exchange works.
- Investment or Business Properties Only
According to the current 1031 exchange rules, investors can’t exchange personal properties, such as residential homes or pieces of machinery. Only investment properties qualify for 1031 exchanges.
- Only Properties of Greater and Equal Value Is Allowed
To avoid paying federal taxes, the replacement property’s net market value and equity must be equal to or greater than that of the property to be relinquished. For example, if you possess a $2,000,000 rental property that you want to trade, you can only replace it with another property valued at least that much.
You can also select several replacement properties with a total value of $2,000,000 or more. If you choose to do a 1031 exchange with more than one replacement property, the total value of all of them mustn’t exceed 200% of the value of the relinquished property. This 1031 exchange rule is known as the 200% rule.
The 200% rule states that an investor can identify an unlimited number of real estate as long as the identified real estate’s total value doesn’t exceed 200% of the relinquished property’s value. Furthermore, if an investor identifies no more than three like-kind properties, the value of the replacement property will not affect the investor’s eligibility for tax-deferred treatment.
This rule, under section 1031, is known as the “three property rule.” The three-property rule states that an investor can identify up to three properties, regardless of their value, and only purchase one.
- Same Taxpayer Name
The name on the relinquished property’s tax return and title must match the name on the replacement property’s acquisition documentation. The sole exception to this rule is if you sell the relinquished property through a single-member limited liability company (SMLLC) and then buy the replacement property in your own name. The IRS doesn’t subject SMLLC to federal income taxes.
- 1031 Exchange Time Limits
There are two types of 1031 exchange time frames. One is known as the 45-day identification window, and the other is known as the 180-day identification window. The 1031 exchange 45-day rule extension limits an investor to 45 days to identify three potential like-kind properties for replacement once the close for the sale of the relinquished property has been initiated.
Furthermore, you have 180 days from when you sell the relinquished property to close on the replacement property. Note that this 180-day window is entirely different from the 45-day timeline. However, the elapse date of both periods begins when the investor sells the relinquished property.
So, following the 45-day time limit, you have a total of 135 days to finalize the purchase of a replacement property.
1031 Exchange Timeline 2021
The 1031 exchange timeline rule states that exchange can’t take more than 180 days or six months. Furthermore, you have 45 days after initiating a 1031 exchange transaction on a property to find or identify suitable replacement properties, and then 135 days in total to close the sale on those properties.
What is the 95% Rule
The 95% rule Is the third and last rule for identifying replacement properties. According to this rule, an investor can identify as many properties as he wants, but he must purchase 95 percent of the total value of the properties he identifies.
1031 exchange rules for 2022 are beneficial to investors hoping to relocate their investment properties to various states without incurring federal taxes from the IRS. Furthermore, these 1031 exchange rules forbid investors from exchanging personal properties such as residential homes.
Furthermore, note that the fees that come with exchanging like-kind properties vary from state to state. Before starting out on your 1031 exchange journey, check your preferred state’s exchange fees and verify what requirements you need to meet to qualify for a 1031 exchange.