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Rules of the 1031 Exchange

Rules of the 1031 Exchange

Capital gains tax on the sale of a property can take a chunk out of a seller’s net profits. The 1031 Exchange is one solution to defer payment on that tax. Essentially, the provision enables the owner to exchange one property for another of “like kind.”

According to the Federation of Exchange Accommodators, Section 1031 of the Internal Revenue Code has this provision — “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment.” The payment of federal income taxes and some state taxes, where applicable, is “deferred.”

Here are the nuts and bolts, provided by Realty Biz News.

  • The owner sells one property and purchases another within a 180-day time frame, meeting all stipulations of the 1031 Exchange (i.e. proper purchase, like kind, and exchange requirement).
  • The capital gains on the sale of the first property are deferred to a future date when the owner liquidates the investment.
  • The major parties involved include the investor/exchanger, the buyer, an intermediary (attorney, title company, or other), and the seller.
  • A 180-day Acquisition Period applies, starting from the closing of the sold property or the due date of that year’s tax return (whichever comes first).
  • Within the first 45 days of Acquisition (known as the Identification Period), the investor is required by law to identify the replacement property in writing. Failure to do so can result in the exchange becoming null or void.

Weigh the benefits of a 1031 exchange and consult with your local tax advisor. The FEA‘s Frequently Asked Questions is a good place to start thinking through the IRS provision and whether your property exchange meets the necessary qualifications.