A 1031 Exchange allows an investor to defer income taxes on the sale of investment property by replacing it with “like-kind” property. There are strict time limits with 1031 Exchanges: you have 45 days to identify replacement properties after selling the original property and you must close the purchase on the selected property within 180 days.
So, even though you have to jump through a few extra hoops, deferring capital gains taxes is worth it, right?
Sometimes it is and sometimes it isn’t. It all depends on the market and your financial situation. Here are just a few examples of when you might consider NOT doing a 1031 Exchange:
1. How’s the Market?
When the market is relatively stable - i.e., it’s neither a buyer’s market or a seller’s market-it’s probably a good time to do a 1031 Exchange. You shouldn’t have a difficult time selling your property or finding replacement property in the allotted timeframes. But what if it’s a seller’s market? There’s no problem selling your property; however, you could face difficulties finding a replacement property . . . and you’ll more than likely pay top dollar for it.
2. What’s Your Financial Situation?
To purchase investment property these days, you must have a down payment (usually at least 10% for a residential property up to 4 units, but more for a commercial property). Will you have the required funds to purchase your like-kind property? Or perhaps you need to sell your property to realize liquidity. Paying capital gains taxes may be a better option than a 1031 Exchange. In addition, the fees associated with a 1031 Exchange could outweigh its advantages. A CPA will help you determine the best strategies for you.
3. Do You Want to Continue Investing?
This is pretty straightforward. Either you do or you don’t. The bottom line is that if you do, the market should be one of your top considerations (see item 1) before you make the decision to do a 1031 Exchange.
There are other things to consider when determining if a 1031 Exchange is the right decision. A visit to your CPA should be your first move.