Section 1031 Like Kind Exchange

The 1031 Exchange is also known as a Starker Tax Deferred Exchange or a Like Kind Exchange. This process is found under section 1031 of the IRS code and states "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."

What this means is that you do not have to pay capital gains taxes on the sale of an investment property, even if you made a profit on it, if you reinvest the money made on the sale into another investment property. The new property is considered a like kind property as long as it is an investment property as well.

By using a Section 1031 Like Kind Exchange you can defer all of the capital gains taxes that would otherwise result from the sale of an investment property. You legally have to use a Qualified Intermediary which represents an unbiased third party to ensure the investor is not committing fraud against the IRS.

The purchase of the replacement property must be within a hundred and eighty days of the close of the sold property. This timeline can be hard to meet, which it why you should have some possible replacement property investments picked out before you do anything else.

The Qualified Intermediary takes care of all of the paperwork and documentation that links the sale of the relinquished property and the reinvestment into the replacement property. The concept of the 1031 Exchange is that the investor is simply exchanging one property for another and is not actually generating taxable income.

It can be compared to trading a dollar for four quarters. If the property investment is "cashed out" and not reinvested then taxable income is generated.

There is a variation of the 1031 Exchange in which other owners are involved. This is called a TIC 1031 Exchange with TIC meaning "Tenants in Common". Finding a replacement property within the forty five day identification and one hundred and eighty day purchase periods can be difficult.

Using investment partners to buy a new property can reduce the risks of the 1031 Exchange and make it easier to find a new property of a like kind. In a Tenants in Common ownership each owner has their own deed and a Tenants in Common owner has the same benefits during a 1031 Exchange as a single owner does.

While a 1031 Exchange can cause a lot of worry, take a lot of time, and contains many seemingly frivolous details, the money that you save by deferring your capital gains taxes are worth it. The money saved is included in the money that you reinvest into a new property and allows you to buy a bigger property than you would be able to afford otherwise.

As confusing as the 1031 Exchange process can be, the safeguards and documentation the IRS asks for are needed to make sure the investor is being honest in the exchange of property.

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