1031 Real Estate Exchanges

Section 1031 of the IRS Internal Revenue Code allows certain types of property to be exchanged and the taxpayer to have the capital gains tax deferred.

In order for a real estate exchange to qualify for Section 1031, the properties must be used in the owner's business or be held for investment purposes. These exchanged properties must also be of a like kind, which means they must be of the same nature. In other words, you cannot sell an investment property to buy a bigger home for your family and have your capital gains tax deferred.

Properties held in the United States are not of a like kind as properties held in another country, so while you can exchange property across state lines and qualify for the 1031 Code, you cannot exchange properties from the United States to another country.

Items and equipment on the relinquished property can be included in the sale of the property as long as the total value of the relinquished property does not exceed the total value of the replacement property. Cash cannot be used to equalize a transaction and any cash used is subject to normal capital gains taxation.

In the past, in order for a transaction to qualify as a 1031 Exchange, the transfer of ownership had to be simultaneous. Since the court case, Starker v. United States, investors are allowed to sell their property and then buy the replacement property later.

There is, however, a time table to follow. The investor must identify potential replacement properties within forty-five days after the close of the original property. And the investor must have ownership of the replacement property within a hundred and eighty days of the close of the first property. This time table can be fairly hard to meet, and that means that 1031 Exchanges can sometimes be risky.

A means of lowering the risk of a 1031 Exchange is to use a Tenant in Common ownership. You and one or more partners purchase a property together. This makes finding a suitable investment property easier and diffuses the risk between multiple partners.

Since partners can pool together more money than any of them can on their own, a larger or more expensive property can be invest in. This allows the co-owners to afford the property that they want but otherwise could not afford.

When going through 1031 real estate exchanges, you have to use a Qualified Intermediary that prepares the documentation of the sale and purchase of the respective properties. This Qualified Intermediary makes sure the transactions are linked and that the taxpayer is not getting out of paying capital gains taxes by way of fraud. The Qualified Intermediary also helps the investor by informing them of the process and answering their questions and concerns.

1031 Tax |