How to Manage & Allocate 1031 Exchange Funds Effectively

1031 Pros

5 minutes ago4 min read

Researchers say that 1031 exchanges generate $27.5 million in labor income for the American economy. As an investor, you only see a small portion of these profits. However, managing 1031 exchange funds is critical.

A 1031 exchange is a complex transaction you can’t complete without help. Your team will help to hold and move funds for you, but you have the final say in how the potential profits are distributed. Here’s what you need to know to make smart decisions.

What Is a 1031 Exchange?

A 1031 exchange gets its name from rules created by the Internal Revenue Service (IRS). Per those regulations, investors can sell one income-generating property and buy another in a structured transaction. They can defer the taxes they would normally pay on the sale and roll them into the new property.

IRS rules specify that investors must identify a replacement property within 45 days of selling the first and complete the transaction within 180 days. These deadlines can’t be shifted or skipped, or the sale becomes taxable.

As the IRS explains, a 1031 exchange doesn’t make your sale tax-free. Instead, this is a tax-deferred process. You must keep track of the funds in your new property, and if you sell, that bill could come due.

Investors can use 1031 exchanges to help them invest in properties in new locations, switch to different places, or otherwise diversify. To make the most of these opportunities, you must manage your 1031 exchange finds properly.

3 Steps to Manage 1031 Exchange Funds

A 1031 exchange is a complex process that involves selling one property and purchasing another. The following three steps are required to ensure that you manage your profits and risks appropriately:

1. Use a Qualified Intermediary

Per IRS rules, you can’t touch the profits of the sale of your property. Otherwise, the entire transaction can become a taxable event. A qualified intermediary (QI) holds your funds in a non-interest-bearing account until the transaction is complete.

The IRS urges investors to choose QIs carefully. In the past, some have gone bankrupt during the 1031 exchange process, leaving investors with taxable transactions. Finding the right QI is the first step in managing your 1031 exchange funds effectively.

2. Consider Easy Investments

A 1031 exchange has a tight time frame with fixed deadlines. Sometimes, they’re very hard to meet. A clever way to manage 1031 exchange funds effectively is to consider a Delaware statutory trust (DST).

As Kiplinger explains, a DST is a prepackaged product designed for 1031 exchanges. Investors can close on them within just three to five days. Investors buy part of a property along with many others, and they’re not required to handle day-to-day concerns like collecting rent or ensuring full tenancy.

Identifying a DST early in the 1031 exchange process can give you a backup plan in case your transaction suddenly goes south. If it does, you can move forward quickly and ensure you don’t have to pay taxes on the sale.

For example, you may want to use your 1031 exchange to sell an apartment building and buy an office park. You’ve identified this property, but during the inspection, a serious hazard appears that you must fix before the sale can go through. Repairs will take longer than 180 days, and you can’t find another office park to purchase in time.

With a DST identified, you could quickly shift strategies and enter a DST instead of purchasing your office park. Your taxes remain deferred.

3. Make Smart Long-Term Purchases

While some properties are difficult to purchase within a 180-day window, others are easy to snap right up at good prices. For example, the housing market is so tight that 65% of potential buyers have lost sleep over their failure to buy. In this market, finding and completing the purchase of a rental multifamily building could be both smart and profitable.

To manage your 1031 exchange funds properly, identify a purchase as early as possible and do everything in your power to make the sale go through. Hire an expert if necessary, and stay in close contact with that team day and night until the sale goes through. Your sale must move forward as fast as possible. Even delays that might seem reasonable or out of your control won’t budge the tight deadlines.

What to Consider When Managing 1031 Exchange Funds

When you’re contemplating a 1031 exchange, ensure that your plans align with your overall investment strategy.

Think about factors like the following:

Property type diversification: Are you over-represented in one market (such as retail) and need to shift to something new? Or is your current mix serving you well?
Locations of new properties: Are you hoping to move out of a risky market (like flood-prone Florida) to something safer (like hot Arizona)? Or do you want to double down in the market where you’re well-represented to reduce your travel demands?
Renovation needs: Are the properties you’re considering in good shape? If not, do you have the funds you need to make repairs? How long will these repairs take?
Current market: Is the property you’re considering able to make you money? For example, researchers say that commercial real estate is associated with poor returns at the moment. Should you take a risk and buy low in the hopes of selling high?

Explore these questions with experts like financial advisors and real estate agents. Together, you can manage your 1031 exchange funds properly.

Get Expert Help With Your 1031 Exchange

As we mentioned, working with the right qualified intermediary is critical to managing your 1031 exchange funds properly. Work with the best in the business. Choose 1031 Pros. We’ve helped thousands of investors just like you with complex transactions that made them money, and we can do the same for you. Contact us today to get started.