Section 1031 of the Internal Revenue Code offers an interesting solution for those looking to exchange investment or income-producing properties without taking a hefty tax hit. Also known as "Like-Kind Exchanges," this transaction allows users to defer various taxes by swapping real estate that is akin in nature, such as trading raw land with developed lots and farmland with apartment buildings. Ultimately, they can benefit from not having their proceeds reduced due to unavoidable tax liabilities when making these types of investments.

IRS Section 1031 Information 

The benefits of a 1031 Tax Deferred Exchange

Section 1031 provides an incredible tax benefit for investors by allowing them to rollover their profits from the sale of one property into another, without needing to pay taxes on it. Amazingly, this can be done multiple times - so savvy real estate investors could potentially keep growing their portfolio indefinitely!  Whether the property is owned by an individual or within the structure of another entity like a corporation, all can benefit from this opportunity.

The types of property that can be exchanged in a 1031 Tax Deferred Exchange

Under Section 1031, many investment properties like rental homes, apartment buildings, and commercial real estate can be exchanged without activating capital gains taxes. For example, you can sell a residential rental property and use a 1031 exchange to re-invest those gains into multiple residential homes or a commercial building.  I have had investors sell a commercial building and buy multiple residential rental properties to replace it with.  This can happen when someone sells a business, or something long those lines. 

This 1031 exchange doesn't apply to primary residences or vacation homes where personal use has been significant as they have different tax codes governing them.  Capital Gains Tax on Home Sales

Who prepares a 1031 Exchange?

To complete a 1031 exchange properly, qualified intermediaries (QIs) are necessary to ensure funds from the relinquished property never come into contact with the investor. There is no single regulatory body governing QI qualifications; however, doing your own research and consulting reputable organizations like The Federation of Exchange Accommodators can help you find experienced professionals who will be able to guide you through this complex transaction.  We have several qualified intermediaries that we can recommend for you as well.  

Link for Federation of Exchange Accommodators 

How to complete a 1031 Tax Deferred Exchange

Selling property via a 1031 Exchange is an effective way of deferring capital gains taxes. The first step in this process is selecting a Realtor who has experience dealing with 1031 exchanges.  These transactions are more complicated than a regular sale and it is essential to have an experienced Realtor who understands what needs to be done with both the sale contract as well as the purchase contract (s). 

As soon as you settle on your sale asset, the exchange process officially begins -- and it's all hands on deck! This includes assigning a Qualified Intermediary (QI) who will help ensure that both settlement timelines are met: 45-days post sale date & 180-day window following receipt of funds from title company. Once these parameters have been satisfied, then you can move forward with identifying/acquiring your "like kind" replacement going into another purchase contract accordingly so that QI may also communicate directly with Title Company for said new acquisition.   

What is the timeline for a 1031 Exchange?

Property swaps have come a long way since the days of simple two-person exchanges. Now, most transactions fall into either delayed exchange, three-party exchange, or Starker Exchange categories to maximize success and avoid unwieldy searches for property matches across vast networks. To complete one of these complex transactions within tax regulations timelines the sale must be identified in writing by day 45 with closing on new properties falling at 180 days after original purchase was completed.

Although 1031 tax deferred exchanges are complicated and there are additional moving pieces, they offer some great benefits.  When these exchanges are done correctly, the process should go smoothly and be very efficient.  Make sure you have the best team possible working on your behalf, if you decide to take advantage of a 1031 Exchange. 

The information provided here is for your general informational purposes.  All information is deemed reliable, but not guaranteed.  It is recommended that you consult your personal tax professional in advance of making a decision.