Understanding 1031 Exchanges in Hawaii: A Complete Guide

What is a 1031 Exchange? A 1031 Exchange allows investors in Hawaii to defer capital gains taxes when selling investment or business property by reinvesting the proceeds into a similar property. This powerful tax strategy can help preserve your investment capital and build long-term wealth.

Key Requirements

1. Like-Kind Exchange: The exchanged properties must be of similar type and quality
2. Investment Purpose: Both properties must be held for investment or business purposes
3. Timing: The entire exchange must be completed within 180 days of selling the original property
4. Qualified Intermediary: Funds must be held by a third-party QI until the replacement property is acquired

Common Misconceptions Clarified

• Investment properties must be exchanged for other investment properties – not personal residences
• Rental income isn’t required but helps prove investment intent
• If family members occupy the property, they must pay fair market rent
• Primary residence sales have different rules ($250,000 single/$500,000 married exemptions)
• Properties with rental units (Ohanas) can qualify partially for both 1031 exchange and residence exemptions

Property Types and Considerations You can exchange any combination of:

• Commercial buildings
• Industrial properties
• Single-family homes
• Condominiums
• Vacant land

Important Notes:

• Exchanging depreciable for non-depreciable property triggers depreciation recapture tax (25%)
• Leasehold properties must have 30+ years remaining on the lease
• Converting an exchange property to a primary residence has specific restrictions

Financial Requirements for Full Tax Deferral To achieve 100% tax deferral:

• Replacement property value must equal or exceed the sold property’s price
• You can deduct legitimate expenses (e.g., realtor commissions, escrow fees) Example:Selling price: $500,000 Less 7% (6% commission + 1% escrow) = $465,000 minimum replacement value
• Buying below this creates a partial exchange with taxable portions

Identification Rules Two options for identifying replacement properties:

1. Three Property Rule:
   • List up to three properties with complete addresses
2. 200% Rule:
   • Identify more than three properties
   • Total value cannot exceed twice the sold property’s price

Critical Deadlines

• 45 days to identify potential replacement properties
• 180 days total to complete the exchange
• Remember to account for holidays
• The 45-day period is included in the 180-day timeline

Cost Considerations

• Regular exchange fees: $950 at sale, $575 at purchase
• While finding the perfect property in 45 days can be challenging, you can always exchange again if needed
• The tax savings typically far outweigh the exchange costs

For optimal results, consult with a CPA before proceeding with a 1031 exchange. Understanding these rules and timelines is crucial for a successful exchange that maximizes your investment potential while minimizing tax liability.