Considering a 1031 exchange from a single-family investment property into multi-family? If you set up the exchange correctly and complete the transaction within the strict timeline, it’s possible.
Here are some things to consider before going ahead with the 1031 exchange.
How a 1031 Exchange Works
IRC Section 1031 allows investors to relinquish real property held for business or investment purposes and replace it with another “like-kind” property. By completing a successful exchange, investors can defer the payment of any capital gains tax that would typically be owed after selling real estate property.
Investors have been using the 1031 exchange for decades to manage tax liabilities by reinvesting the proceeds from the sale of an investment property into other like-kind assets. Here are some basic rules investors are required to follow to complete an exchange:
- Relinquished and replacement property or properties must be “like-kind.”
- The properties must be used for business or investment purposes.
- The replacement property or properties must be of equal or greater value than the relinquished property.
- The name on the title of the replacement property must be the same as the relinquished property.
- The replacement property or properties must be identified within 45 days of the closing of the sale of the relinquished property.
- The replacement property or properties must be purchased within 180 days of the closing of the sale of the relinquished property.
- A Qualified Intermediary is required by the IRS to complete the exchange.
- The QI must hold the proceeds during the exchange.
- The investor must complete IRS form 8824 and include it as part of their tax return in the year in which they sold their relinquished property.
Defining a Like-Kind Replacement Property
There’s been confusion surrounding the definition of the term “like-kind.” The like-kind requirement doesn’t mean selling and buying the same type of property. The IRS defines like-kind property as having the same nature or character, even if they differ in grade or quality. In other words, real property must be exchanged for real property.
You can exchange a single-family property and exchange it for a multi-family property because they are both defined as like-kind properties by the IRS. This flexibility allows investors to diversify real estate investments and reinvest proceeds into different property types.
Single-Family to Multi-Family 1031 Exchange Restrictions
All real property held for use in business, trade, or for investment purposes is qualified for exchange purposes. If the single-family property was used as a primary residence, then there are certain steps you must take before it’s 1031 eligible.
You can convert your single-family residence into a rental property (meaning you are renting it to tenants and no longer personally occupy the property) and use that in a 1031 exchange for a multi-family property. The tax code does not specify how long that property must be held for rental purposes, but most professionals agree to wait for at least one to two years and be sure you can prove that it was used for business or investment purposes during that time.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.