What Is A 1031 Exchange

A 1031 Exchange is a transaction that comes under the purview of Section 1031 of the Internal Revenue Code or IRC of United States Law. A 1031 Exchange is also commonly referred to as a Like Kind Exchange. Another name it is known by is the Starker Tax Deferred Exchange. It derives this name from Starker, an investor who challenged the Internal Revenue Service (IRS) in a legal battle and won the case.

So what is the premise on which a 1031 Exchange is based? Basically, any profitable transaction involves the element of profit or loss. If you make a profit, it is taxable by the government. The only exception is any capital gain made while selling property, under special stipulations.

This is where a 1031 Exchange comes into play. The 1031 Exchange law 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.

According to this rule a person dabbling in real estate can defer any taxes he might otherwise have had to pay for profiting from the sale of a property. What are the conditions that make this kind of deferment permissible?

First, the person should have conducted the transaction in strict compliance with existing local, state, and federal real estate laws.

Second, the person should have used the money obtained through this transaction to fund the purchase of more property within 3 months of the date of sale. Third, the property being sold and the property being bought must be either investment property or company property.

So does this mean that he can buy property of any valuation after the sale of the first property? What if he bought a property that was valued at less than the value of the property he sold? In that case the 1031 Exchange would not work. Any property that he buys has to be valued either equal to or higher than the value of the property he sold.

Any debt attached should be also either higher than or of the same value as that of the property sold. The only situation where a concession can be made is if the person involved makes a cash addition to take care of the debt involved. Also, in this scenario, the money that he makes from the sale should be totally spent on the purchase of the other property.

Simply put, a 1031 Exchange allows you to sell a property and use the money from that sale to buy another one without paying taxes on the income from the sale.

So far, a 1031 Exchange seems like a great idea while considering financial matters like your investments and taxes. However, it is not the all-purpose tax cure. There are some limitations to a 1031 Exchange too. A 1031 Exchange has no standing if you choose to exchange stocks, bonds, inventory, specific assets, other securities, etc.

The 1031 is a useful tool to use should you choose to invest in the real estate market, but always remember to consult with a tax attorney or a licensed realtor for all specific situations.

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