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How to Do a 1031 Exchange in Florida

When you’re looking to grow or update your real estate portfolio, a 1031 exchange offers you a valuable opportunity. It allows you to “swap” one real estate investment property for another to avoid paying capital gains tax.

You can double down on this tax break within Florida since the state is tax-free. This creates an attractive opportunity to increase the value of your portfolio in a competitive and lucrative marketplace.

In this article, you’ll find what you need to know to complete a 1031 exchange in Florida. This will guide you through all the essential elements you need to remember, from timelines to budgeting, so you can take advantage of this tax deferral.

1031 Exchange Simplified

Through a 1031 exchange, you can defer the payment of capital gains on the sale of a business or investment property by reinvesting the sale earnings into another like-kind property. This is a tax advantage that allows you to grow the value of your real estate investment portfolio.

A 1031 exchange in Florida offers the additional benefit of taking place in a tax-free state. This means that on top of deferring your federal capital gains taxes, you don’t have to worry about capital gains costs at the state level.

This means that the 1031 exchange rules in Florida are more accessible to navigate than in other states. Florida is one of only nine tax-free states. (Texas is another state that’s tax-free as well.)

While a 1031 allows you to exchange one property for another, you can’t exchange any property for another. It has to be a business or investment property. Principal residences or vacation properties do not meet the property requirements for a like-kind exchange.

Step 1: Assessing Your Need for a 1031 Exchange

There are many different situations where a 1031 exchange is in your best interest, for example, if you’ve made an investment in the past but are looking to change the type of property you own. A 1031 exchange would allow you to do this. You could go from a condo situation where you’re a hands-on landlord to a triple-net lease where you can be more hands-off. Rather than losing all you’ve invested, you can trade your investment property for another.

The ability to do this also makes a 1031 exchange a great option if you’d like to consolidate multiple investment properties or diversify your investments, as you can “swap” multiple properties for a single one and vice-versa.

Of course, a 1031 exchange does not completely create a tax-free sale; it defers the payment to a later date.

Step 2: Selecting Suitable Replacement Properties

As mentioned earlier in the article, you can’t use a 1031 exchange for principal residences; the properties being exchanged must be for investment or business purposes. In addition to this, there are also important 1031 exchange rules to be aware of when identifying replacement properties for your qualified intermediary. Most notable are the 95% rule and 200% rule.

These rules indicate the value and amount you can spend on a replacement property while remaining eligible to claim a 1031 on your tax return.

Because of these rules, it’s imperative to carefully plan and budget your current property's value and potential replacement properties' value. This will also help you avoid what’s referred to as a 1031 exchange boot down the line.

There are no restrictions on the type of business or investment or where the replacement property will be. But, to look out for your long-term best interest, it’s important to be aware of market trends that may impact where you’re looking to invest.

Step 3: Initiating the Exchange Process

You’ll need a qualified intermediary in Florida to get started on your exchange. A qualified intermediary is a person or company, such as Net Lease Finder, that will hold the sale earnings and purchase the replacement property on your behalf. Without them, you can not claim a 1031 exchange.

Throughout the process, your qualified intermediary needs to be notified each step of the way, as there are strict 1031 exchange time limits in Florida. These time limits give you 180 days in total to complete the exchange. Within 45 days of the 180-day window, you must notify your qualified intermediary of potential replacement properties.

The 180-day window starts when the property ownership for the existing property changes hands. If a replacement property is purchased before the current property is sold, the 180 days start from when ownership is transferred for the replacement property.

Step 4: Navigating Florida-Specific Considerations

Florida is a tax-free state, meaning you’ll have fewer tax considerations when performing a 1031 exchange there, as you won’t have to worry about state-level income taxes. You’ll only need to be aware of 1031 exchange rules at the federal level.

When purchasing a property in a tax-free state, there are some additional considerations and factors to consider. This includes more competition for real estate and a slightly riskier investment. The flip side of this is that because there are no income taxes, overall operation costs are lower, and you have more potential for appreciation of your investment.

These different factors at play for a 1031 exchange in Florida and any other tax-free state mean you want to be careful when evaluating the market and making investment decisions.

Step 5: Due Diligence and Financial Considerations

Many small but important details will impact whether or not you’ll successfully defer capital gains tax for your property exchange. You want to be sure that the value of your current property and your replacement property fall within the earlier noted 95% and 200% rules. This is imperative to avoid an “exchange boot,” which means you’ll end up being taxed on unforeseen differences in property value.

What causes unforeseen value differences? Not being aware of what can and can not be applied to the value of each property or claimed on your tax return in relation to the exchange process. For instance, you can not include any repair or realtor fees associated with a property in an exchange's closing costs.

Another unforeseen way you can be taxed is by overborrowing a loan to assist with purchasing a replacement property. If you end up with excess cash after purchasing your replacement property, you will be taxed on this.

To avoid any unwanted taxable income or surprise out-of-pocket fees, you want to be aware of all financial considerations that may come up during the exchange process before you initiate the exchange.

Step 6: Mitigating Risks and Ensuring a Smooth Transaction

The best way to reduce risks or hiccups in your exchange process is to plan out as much as possible before initiating the exchange. Carefully set the budget, start looking for replacement properties early, and ensure you have a qualified intermediary.

Each of these will help you successfully make and claim your 1031 exchange to grow your real estate investment portfolio.

Step 7: Future Trends and Considerations

As with anything, the market around real estate and its applicable taxes are constantly changing. For instance, this year, Florida will be implementing a “tax holiday” that limits sales tax on retail goods for a set period of time.

Florida has also seen interest rate hikes over 2023, as is the case in most places, but this market has also seen a diminished supply of real property, creating a market that is even tougher to break into. In fact, it’s become so lucrative that Florida’s housing market is now the second most valuable in the country.

When it comes to the 1031 exchange, there has been debate about who will be able to claim this tax deferral. The Bidden administration has been looking for ways to increase funds for elder care, child care, and health care, and one idea being explored is limiting 1031 exchanges to specific individuals.

These big and small changes can hugely influence your investment portfolio, so keeping careful tabs on updates and changes is incredibly important to making informed decisions when considering a 1031 exchange.

Conclusion

If you’ve been evaluating your portfolio and find that a 1031 exchange is the best option for you to grow your investment(s), these are the key steps and details to keep in mind:

  • Look for replacement properties sooner rather than later while keeping in mind the 95% and 200% rules
  • Seek out a qualified intermediary to work with for the duration of the exchange process
  • Budget and carefully plan to avoid a 1031 exchange boot
  • Keep tabs on the Florida market and tax regulations

Doing a 1031 exchange in Florida will allow you to grow your real estate investment portfolio and mitigate your tax burden. Get in touch with our team today and get the guidance you need to navigate your first 1031 exchange.