Everything You Need to Know About 1031 Exchanges in Oklahoma
With a strong economy, affordable property prices, and a diverse range of cities and geographies, Oklahoma is an attractive state for real estate investors. Whether you were born here or you’re looking to enter the market, you’re probably looking for ways to maximize your portfolio and minimize your taxes.
The 1031 exchange, a powerful tool in the world of real estate investing, could be the answer. Named after Section 1031 of the Internal Revenue Code (IRC), it’s a way for property owners to defer capital gains taxes when they sell an investment property. The process for a 1031 exchange in Oklahoma can be complex, but an experienced attorney can help you make a successful transaction.
What Is a 1031 Exchange in Oklahoma?
A 1031 exchange is a tax-deferral strategy that allows real estate investors to postpone paying capital gains taxes on the sale of an investment property. That means they can grow their portfolios faster. To qualify, the investor must reinvest the proceeds into another property of equal or greater value.
All 1031 exchanges fall under the IRC, which is a federal code. Oklahoma follows the same rules as other states under this code. Key rules to remember include strict timelines and the requirement to use a qualified intermediary, who holds the proceeds from the sale until they can be transferred to the seller of the replacement property. We’ll go over all of that in this article.
Types of 1031 Exchanges
There are three types of 1031 exchanges in Oklahoma and elsewhere, depending on when the properties are acquired and sold.
Simultaneous Exchanges
In a simultaneous 1031 exchange, also called a direct exchange, the sale of the original property and the purchase of the replacement property occur on the same day. This type of exchange is the most straightforward but requires precise timing and coordination. Investors typically choose this route when they already have a replacement property lined up and can close both transactions quickly.
Deferred Exchanges
Deferred exchanges are the most common type of 1031 exchange. In this scenario, the investor sells the original property first. They then have 45 days to create a list of potential replacement properties, and up to 180 days to close on one of those properties.
During this period, the proceeds from the sale are held by a qualified intermediary so that the seller never actually possesses them (this is important for tax purposes). Deferred exchanges are a popular choice because they’re flexible and provide more time to find a suitable replacement property.
Reverse Exchanges
In a reverse 1031 exchange, the replacement property is acquired before the original property is sold. Investors might use this approach in a competitive market where they don’t want to risk losing a desirable property. However, reverse exchanges are more complex and expensive because you’ll need to make temporary property ownership arrangements.
Benefits of a 1031 Exchange
This type of exchange is popular in Oklahoma for a reason—1031 exchanges offer a lot of benefits for real estate investors
- Tax deferral: The biggest benefit is the ability to defer paying capital gains taxes, leaving you more capital to reinvest.
- Increased cash flow: By deferring taxes, you can use more of your sale proceeds to buy a larger or more profitable property.
- Wealth accumulation: Tax deferral also means you can reinvest your gains repeatedly, so you can grow your portfolio faster and accumulate more wealth over time.
- Portfolio diversification: You can exchange one property for multiple properties or a different type of real estate, diversifying your holdings.
Property Requirements for 1031 Exchanges
Properties being exchanged under Section 1031 need to be “like-kind.” However, the term “like-kind” is broader than it seems. It doesn’t mean you have to exchange an office building for another office building, for example. As long as the properties are both used for business or investment purposes, they can be considered like-kind. For instance, you could exchange a residential rental property for a commercial office building or even vacant land.
However, some exchanges are prohibited. Personal residences, inventory properties, and properties held primarily for resale (like fix-and-flip projects) don’t qualify under 1031. Also, properties located outside the U.S. are not considered like-kind with domestic properties.
Restrictions on 1031 Exchanges
It’s also important to note that 1031 exchanges used to apply to both real property, which means real estate, and personal property, like vehicles. However, after the passage of the Tax Cuts and Jobs Act of 2017, they now only apply to real property. That means you won’t be able to exchange the following as a 1031 exchange in Oklahoma:
- Artwork
- Certificates of trust
- Inventory or stock in trade
- Jewelry or other valuables
- Machinery or equipment
- Partnership interests
- Securities or debt
- Stocks, bonds, or notes
- Vehicles
1031 Exchanges, Trusts, and Estate Planning
A 1031 exchange can be a valuable tool in estate planning. When you acquire property through a 1031 exchange, the taxes are deferred until you ultimately decide to sell the property in a standard sale. When you sell the property without a 1031, Uncle Sam will come calling—sometimes to the tune of 30% of the profits.
However, these tax liabilities end upon your death. If you pass away as the owner of the property, your heirs can inherit it without owing any taxes. That’s because the value of the property is “stepped up,” or reassessed, to the fair market value at the time of your death. Because they inherit the property at the fair market value, they can sell it immediately for that price without owing any capital gains taxes.
Combining 1031 exchanges with trusts and other estate planning tools can mitigate tax liabilities even more, plus ensure a smooth transition of assets to the next generation. What if you have property in a trust that you want to use in a 1031 exchange? You can do that too, as long as you set up a living trust that’s considered a disregarded entity.
Set Up a 1031 Exchange in Oklahoma
Thinking about setting up a 1031 exchange? An experienced attorney can help you navigate the complex IRS code and resolve issues that might complicate the process. An attorney can manage deadlines, draft your documents, oversee the qualified intermediary, and make the process go as smoothly as possible.
Contact Plan Ahead Legal to learn more about how 1031 exchanges can benefit you now and in the long-term.