Owners of property in the White Mountains Region of New Hampshire “especially owners in the Waterville Valley and around Loon Mountain” tend to be investment property owners. As such, these people have the opportunity to save thousands in capital gains taxes when it’s time to sell.

Though many people use real estate as a form of investment, here we’re using the term “investment property” as the Internal Revenue Service defines it in the tax code.

Simply put, an investment property is either:

• A home you own that is not your primary residence
• Undeveloped land
• Multi-family properties, such as apartment buildings
• Commercial properties

These are the properties that qualify for sale under IRS Section 1031, the “like-kind” exchange.

What is a 1031 Exchange?
It’s a limited-time opportunity to sell investment property for the sole purpose of buying a different investment property. Because you’re just “exchanging” one investment property for another, you never realize the monetary gain (or loss) from the investment property sale.

As such, you don’t have to pay capital gains taxes on the transaction, until you take your money out of real estate altogether, or if you don’t identify a new investment property to buy within the IRS’ time limit.

How does it work?
It works a lot like escrow. The proceeds from your investment property sale go to a “Qualified Intermediary” or QI, who holds the funds until you identify another investment property for purchase. Then the QI disburses the funds at the time of closing on the new investment property.

Those are the two most common questions we get about 1031 exchanges, and we’ll answer more of them later. For now, though, we’d like to address some of the common misconceptions we hear about 1031s, and put them to rest for good.

1031 Exchanges: Fiction and Facts

Fiction: I’d like to avoid paying capital gains taxes on a real estate sale, but that leaves me with limited options for purchasing my next property.

Fact: “Like-kind” includes these kinds of exchanges:

• A duplex for a four-plex
• Land for a condo
• A condo for a hotel
• A strip mall for an office building

It’s true that there are some limits (like on purchasing a primary residence), but they’re much fewer than some people think.

Fiction: The property exchange must happen at the same time, and everyone knows how difficult it is to schedule two closings on the same day.

Fact: The most common type of 1031 exchange is a “deferred” exchange (read more about that below), which means that it’s perfectly normal and common NOT to do the exchange on the same day.

Fiction: The two parties involved with the exchange must be willing to trade for each other’s property.

Fact: Yes and no. Trading property is just one way to reap the benefits of a 1031 exchange. The majority of 1031 transactions don’t involve a trade – they simply require a Qualified Intermediary (QI) to hold your funds, like escrow, until you find another property to buy.

Whether you add money to the new purchase or have money left over is up to you. And because buying for more or less than the price of your sale can have different tax ramifications, be sure to talk to your tax professional in advance.

Fiction: I can’t use other investment vehicles to purchase investment property without incurring an income tax penalty.

Fact: A self–directed IRA may be used to purchase investment property. This is a fine option for people more comfortable with using their IRAs than real estate assets in executing their 1031 transactions.

Like real estate, self-directed IRAs also provides tangible assets where you don’t receive the proceeds as part of the sale portion of the transaction. And your IRAs may continue to appreciate while you go through the process, while other assets may not. Ask your financial consultant for more information.

1031 Exchanges: Frequently Asked Questions

Do I have to buy an investment property of equal value?
No, you can buy an investment property for greater or lesser value, too! But there will be tax consequences to not spending at least the amount of the selling price of the “relinquished” or “disposed” property.

Can I buy more than one property with the exchange?
Yes you can. Just keep in mind that there’s a time limit set by the IRS, so make sure you understand as much about the 1031 process before your sale, so when you get into it, you’ll be ready to identify your replacement properties in a timely manner.

Can I take some cash out of the sale when performing a 1031 exchange?
Yes. And knowing the rules that govern the qualified exchange will help you avoid future IRS issues, so be sure to talk to your tax professional or a real estate agency like ours with extensive 1031 experience.

If I sell raw land, can I make an exchange for a property with rental income?
Yes. As long as the IRS defines it as an “investment property,” it doesn’t matter what kind of property it is.

Can I use a 1031 exchange to sell property in New Hampshire, and buy property in another state?
Though laws vary from state to state, most states allow this type of exchange without question. A few impose certain additional restrictions – check with your tax professional for more information.

If we acquire a property using a 1031 exchange, will it create a bigger tax burden for my heirs than they might already have?
No. Without the exchange, a property with a low basis, when sold at fair market value, would have greater tax consequences.

What happens when we sell what we bought using a 1031 exchange?
When you sell stocks, bonds, or mutual funds and immediately use the proceeds to buy different securities, you don’t pay taxes. You only pay when you cash out. And it’s the same with the 1031. The capital gains tax is triggered only if you don’t exchange again. It’s the opportunity to keep exchanging up to nicer or better income property opportunities that makes the 1031 exchange so great.

Can we build with exchange money, or can we buy before we sell using a 1031 qualified exchange?
You can do both! The processes are a bit more complex, and much depends on your particular situation. One thing we can say in this short space is that advance planning is a must – call or email us to talk about your individual situation, and let’s see what we can do to help.

Give me a real-world example where you’ve seen the benefits of a 1031.
An Alpine Lakes client sold a duplex he’d been renting to tenants for years, and used the money to purchase a replacement property in the White Mountains. The new property, part of a ski resort, had a rental program that was managed for him while he was out of state.

He contacted us several years later, as his son was about to start college. The value of the ski home had appreciated, and he’d been collecting additional rental income. We suggested he consider buying apartment buildings near the college campus when we sold the ski house, and he did!

After four years of ownership (and the son’s degree to show for it), the apartment was sold, and replaced with a condo near the beach in Florida - again with an on-site rental program.

With his retirement a few years away, the Florida property would pay for itself until out client retired to enjoy it - debt free.

What kinds of exchanges are there?

The four most commonly used exchanges are:

Deferred Exchange. The taxpayer (person or persons party to the exchange) have 45 days after the initial sale to identify a replacement property(ies), and complete the purchase of the replacement property(ies) within 180 days (with some caveats regarding acquisitions prior to the next tax year’s filing and any required extensions).

Reverse Exchange. The taxpayer acquires the new property before the relinquished property has sold. With some variations, the above 45- and 180-day rules apply.

Personal Property Exchange. In this case, “like-kind” takes on a more literal meaning. You could exchange a piece of timber equipment for another piece of like equipment, or an airplane for an airplane. You get the idea.

Construction Exchange. For this type of exchange, the land and any improvements would be paid for in advance on a new property, up to the total amount of the sale of the relinquished property. Funds must be paid out within the 180-day period allowed in the other type of qualified exchanges.

Does Alpine Lakes help with 1031 exchanges?

Absolutely. We’ve helped clients complete 1031 transactions many, many times, and we can guide you through the whole process. It’s important to plan in advance for it, though, because any mistakes or missed steps in setting up the 1031 exchange can wind up costing you.

Call Alpine Lakes Real Estate at 800-926-5653, or email at alre@alpinelakes.com if you’re thinking about selling income property or land held for investment in New Hampshire. Let us help you take the steps necessary in qualifying the sale as a 1031 exchange, explain the process in easy-to-understand detail, and help make this tax-saving opportunity a reality for you.