An important truth about 1031 exchanges is that you cannot make use of the proceeds off the sale of your relinquished property to fund improvements on property you own. This is a frequent pitfall for unwary real estate investors. To qualify for tax deferment, the replacement property must be of like kind with the property it is replacing. Thusly, the property you acquire as a result of the 1031 exchange has to comprise real estate with a value greater than or equal to that of the property sold. A renovation that is incomplete constitutes a contract for service, which constitutes personal property but not real estate. Due to the fact that a property purchased as a replacement in a 1031 exchange has to be of like kind and equivalent value with the relinquished property at the time of closing, it can be difficult to find one that fulfills these legal requirements and also fulfills his or her specifications.
Next time you are planning to sell a piece of real estate or other type of investment property, pause for a moment to consider the potential profit you could gain were you to exchange instead. If you decide an exchange rather than selling your property outright, you can maximize your wealth and come out ahead.