How to Use a 1031 Exchange for a Foreign Investment Property

May 24, 2022

Suppose you have a foreign property you no longer want, and you wish to swap it for a ‘like-kind’ one, or perhaps you want to relocate and need to offload a landed asset for another one in a different location. 

If you fall into either category, you’re in the right place. Many exchangers are unaware that international real estate qualifies for 1031 exchange taxation treatment. Although it can be challenging, carrying out a foreign property exchange is achievable.

This article will teach you how to use a 1031 exchange for a foreign investment property. Keep reading to find out more.


Frequently Asked Questions Concerning 1031 Exchanges

Before delving into the procedures involved in using 1031 exchanges for foreign properties, we’ll go over some questions people often ask about the term:

What is a 1031 Exchange?

A 1031 exchange refers to a property investment tool that lets investors exchange one investment asset for another while deferring losses, capital gains, or capital gains tax that would otherwise be due at the sale period. This technique is prevalent among investors who want to grow their real estate portfolio without paying taxes on the proceeds. 

1031 exchanges are also known as Starker exchanges or like-kind exchanges. Although Section 1031 covers property besides real estate, several 1031 cases also involve land and buildings.

Also, don’t forget to read: How Do I Get a Valuation on a Property?

Can You Sell Multiple Properties in a 1031 Exchange?

The short answer is yes, you can. A 1031 exchange of multiple properties or assets occurs when you locate and acquire one or more like-kind replacement assets or sell and transfer one or more relinquished assets.

However, calculating any recognizable excess gain can become more complicated when multiple assets or properties are engaged in the tax-deferred exchange process.

Two 1031 rules increase the complexity from the start. The 45-day rule restricts the time frame for identifying property. Seeing as the concerned parties usually sell their assets during this period, any delay in completing these sales shortens an already short deadline. Then, within 180 days from the same start date, you must close on the replacement(s).

Furthermore, special rules restrict the aggregate value and number when more than three replacements are involved. However, if selling many properties is still your goal, carefully consider the best approach.

Consider weighing the benefits of having only one 1031 swap versus splitting the sales and purchases into different 1031 exchanges against the risks of making all the sales within 45 days and subsequent acquisitions within 180 days. Additionally, besides swapping your local real estate structures, you can use 1031 exchange for foreign property too, and here’s how:

How to Use a 1031 Exchange for a Foreign Investment Property

In the United States, a 1031 exchange allows you to swap one property for another while avoiding capital gains taxes. Similarly, a 1031 swap of foreign landed properties will enable you to switch one foreign real estate for another while retaining similar tax benefits. 

However, keep in mind that any profit from selling properties in the US is subject to the country’s taxation. It makes no difference if the asset is outside the States; the Internal Revenue Service will want their cut if you have a blue passport. 

A 1031 swap of foreign property applies to commercial or foreign real estate holdings. An adequately organized 1031 swap of foreign real estate enables you to sell foreign assets and reinvest the earnings in a new international property while deferring all capital gains taxes, thanks to the Internal Revenue Code Section 1031.

You can exchange one US commercial property for another US structure or an international investment real estate structure for another foreign investment asset.

However, it isn’t permissible to swap a foreign real estate structure for a United States property or a US-based asset for an international one. While the two properties don’t have to be in the same nation; they should be outside the US. 

1031 Exchange Foreign Property Guidelines

The 1031 swap rules for a foreign property are similar to real estate in the US. However, you can’t treat international properties the same way as structures held in the United States and vice versa. The following is a quick rundown of the primary exchange guidelines:

Exchange Value

The net replacement real estate acquisition price should be equal to or higher than the net surrendered structure selling price to delay the capital gain. Partial swaps are also permitted.

Timeline

You must finalize the transaction within 180 days after the initial closing. Then, the substitute real estate must be identified, ideally to an eligible Intermediary, before midnight on the 45th day after the close.

Same Taxpayer

Excluding a dismissed entity, like a single-member LLC, the taxpayer that sells must also be the taxpayer that buys.

Related Party

You’ll trigger the delayed gain if the subsequent sale of 1031 exchange property doesn’t occur within two years of the deal. Additionally, if a related entity is starting a 1031 swap, You can obtain the replacement structure from them.

Issues With Foreign 1031 Exchanges

Constructive Receipt

Each country’s closing procedure is unique. What people consider regular protocol in the United States can’t be assumed to be standard practice in other places. 

For instance, if the seller gets a check in a 1031 swap, the exchange is null and void because the taxpayer can now access the funds, violating the (g)(6) constructive receipt prerequisites. Therefore, the taxpayer must grant the eligible middleman access to their legal and financial counsel to share sovereign closing procedures. 

Keeping Exchange Funds in Your Country

Can money be held domestically in local currency instead of in an American escrow account? This action necessitates converting the swap funds to USD and then back to the national legal tender for the replacement real estate acquisition, putting the exchange funds at risk of loss or gain during the currency exchange.

In Conclusion

If you’ve been wondering how to use a 1031 exchange for a foreign investment property, there’s no need to fret because the procedure isn’t that different from swapping a local one. There are only a few modifications to the rules. So be sure to familiarize yourself with the process before embarking on it.


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