1031 Exchange

What is a 1031 Exchange?

A 1031 Exchange, also known as a Like-Kind Exchange or a Starker Exchange, is a tax-deferral strategy used in the United States. It’s named after Section 1031 of the Internal Revenue Code. This provision allows investors to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a similar, or "like-kind," property within a specified time frame.

In a 1031 Exchange, the property being sold and the property being acquired must both be held for investment or used in a trade or business. These properties don’t have to be identical but must be of the same nature, character or class. Investors must follow strict rules and time limits for identifying and closing on the replacement property to qualify for tax deferral benefits.

It's important to note that a 1031 Exchange is not a tax-free transaction; instead, it allows investors to defer paying capital gains taxes until they eventually sell the replacement property in a taxable transaction.

How Do Real Estate Investors Use Hard Money Loans to Execute a 1031 Exchange?

Real estate investors often use hard money bridge loans to finance a regular 1031 exchange or a reverse 1031 exchange. Going the private loan route may be the best option when the investor is acquiring a property in need of renovation that doesn’t qualify for bank financing, or if they need to close quickly to meet the exchange deadline.

A regular 1031 exchange involves selling a property and using the proceeds to purchase another property within a specific time frame. In a regular 1031 exchange scenario, an investor will use the down payment proceeds from the sale of the existing property, then take advantage of the leverage of the hard money bridge loan to complete the transaction, which closes out the 1031 exchange. After acquiring the property, renovating and/or leasing it, the investor can then refinance into long-term bank or institutional financing.

On the other hand, a reverse 1031 exchange involves acquiring a replacement property before selling the existing property. In this scenario, the hard money bridge loan finances the purchase of the replacement property while the investor works to sell the existing property. Often, in these situations, the lender will do a cross-collateralized blanket loan, using the equity from the existing property as additional collateral to acquire the replacement property with little to no money out of pocket. Once the sale is complete, the investor can use the sale proceeds to pay off a portion or the entirety of the hard money blanket loan.

First Capital Trust Deeds (FCTD) has secured private money financing for numerous regular 1031 and reverse 1031 exchanges. FCTD works with borrowers, real estate agents, real estate attorneys, the escrow officer and the 1031 exchange accommodator to ensure the transactions close within the deadline.