The 1031 Tax Deferred Exchange in Brief
The 1031 Exchange is named for Section 1031 of the IRS Tax Code. It is also known as a Starker Exchange and a Tax Deferred Exchange. It is one of the must-know commercial real estate terms. Under this section of the Code, investors can sell one or more pieces of real estate and purchase one or more pieces of equal or greater value while deferring payment of any capital gains tax (CGT) on the profit. To qualify the sale and purchase as a 1031 Exchange there are specific rules that must be met. By deferring CGT, investors have more capital available to cover the transactions.
The Basic Rules for a 1031 Exchange
- All properties involved in the exchange must be what the IRS considers to be “like-kind.” This means they must be real estate. They may not include anything other than raw land or improved property. Equipment, work trucks, patents, etc. cannot be part of a 1031 Exchange following the Tax Cuts and Jobs Act of 2017.
- The properties must be held for investment or business purposes.
- The properties must be within the USA or American territories.
- The transactions must be handled by a qualified intermediary. Many title agents and attorneys are approved intermediaries.
- The sale proceeds must be held by the intermediary and applied to the subsequent purchase, not turned over to the seller, since this would count as a regular sale and purchase on which CGT would be immediately due.
- The terms “sale” and “purchase” are replaced with “relinquished” and “acquired.”
Advantageous Flexibility is Built In
A 1031 Exchange may be completed as follows:
- The sale of one or more properties and purchase of one or more replacement properties may be completed simultaneously.
- The sale may be completed (all proceeds remain with the intermediary) giving the seller 45 days to identify other property/properties to acquire and then another 135 days (180 in all) to complete those purchases. The intermediary handles all the paperwork that qualifies the deferred purchase(s) as part of the same exchange.
- Properties may be acquired using the same time frames before currently owned properties are relinquished. This is known as a Reverse Exchange.
A 1031 Exchange is an excellent way for real estate investors to defer CGT payments. If you would like to learn more about how you can make best use of the 1031 Exchange process or if you have other questions, please just click this link to contact us.