Entering a 1031 exchange allows investors to defer capital gains taxes by reinvesting proceeds from the sale of investment property into like-kind replacement property. When you undergo this transaction, you’ll work with various professionals — some strictly required and others there to make the process much easier. In the second category are lenders.
Do lenders do 1031 exchanges? Yes, and they play a significant role for investors who require financing for the transaction.
In this article, Realized 1031 discusses the role of the 1031 exchange lender to help you determine if engaging with one is necessary for your like-kind swap.
A Refresher on 1031 Exchanges
The 1031 exchange is a tax-deferred strategy that allows you to exchange one investment or business-use real property for another of like kind, deferring recognition of capital gains taxes if the exchange satisfies all IRS requirements. In addition, the transaction must be completed within a 180-day window, with the first 45 days allocated to formally identifying replacement properties. Investors may defer capital gains taxes through successive like-kind exchanges, although taxes may ultimately become due when a property is sold in a taxable transaction.
To achieve full deferral of capital gains, the investor must reinvest all proceeds into one or more replacement properties of equal or greater value and replace any debt retired in the relinquished property. If the replacement property is of lesser value, the difference—known as "boot"—may be subject to current taxation.
In this discussion, the most relevant rule is the equal-or-greater-value requirement. The value of the replacement property must match or exceed the relinquished one’s, including debt and equity. Otherwise, the leftover cash will be treated as boot and is taxable. These scenarios make lenders necessary.
What Is a 1031 Exchange Lender?
Financing may be required for investors who want a replacement property that has a higher value than the relinquished one. In addition, if you had a loan on the original property, you may need to replace that debt when buying the new real estate asset. Lenders allow you to meet the equal-or-greater-value requirement for full tax deferral by providing the funds through loans or structuring financing. 1031 exchange lenders, in particular, specialize in financing services that accommodate the rules and timelines of the like-kind exchange.
The Role of the 1031 Exchange Lender
Lenders may play a supporting role in 1031 exchanges by providing financing solutions for this transaction. Not all loan products are suitable for a like-kind exchange; it can be helpful to work with lenders familiar with the exchange process who can offer tailored loan options. Here are a few examples.
- Bridge loans can offer temporary financing while investors transition between properties.
- Non-recourse loans might be ideal for those seeking to limit personal liability.
- Interest-only periods can ease cash flow concerns during the exchange process.
Inadequate financing is a common cause of failed exchanges. Working with a lender familiar with the structure and timeline of a 1031 exchange may help reduce this risk. Lender-related issues are a common reason for like-kind swaps that fell through — delayed closing, loan denial, inadequate debt replacement, etc. Because delays or inadequate financing can contribute to failed exchanges, working with a lender familiar with 1031 exchanges may help mitigate timing or structuring risks.
Lenders also work with your qualified intermediary to help facilitate timely closings and ensure financing is in place during the 180-day window. A 1031 exchange lender also typically understands how to navigate title and escrow instructions that may include the qualified intermediary’s involvement, which differs from a standard real estate transaction.
Wrapping Up: Understanding the Importance of 1031 Exchange Lenders
Among the professionals or companies you’ll work with during a 1031 exchange, lenders can play a supporting role in a 1031 exchange by offering financing solutions that align with the transaction’s timing and reinvestment requirements. These entities provide financing solutions, debt restructuring, and other services. These insights may assist investors in navigating the financial elements of a 1031 exchange and identifying financing solutions that align with their specific transaction goals.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.ftb.ca.gov/pay/withholding/qualified-intermediary.html
https://www.investopedia.com/terms/l/lender.asp
https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx
