What is A 1031 Exchange?

What is A 1031 Exchange?

What is A 1031 Exchange?

A 1031 exchange is the exchanging of one investment asset for another. This takes place by deferring the tax consequences of the sale of the investment asset. If done properly, minimal to no taxes would be imposed, as explained by section 1031 of the IRS Code. However, this means that the tax is deferred only until the sale of the asset for cash, which then is a single tax at a long-term capital gain rate. The property or asset that is exchanged must be used in trade, business, or for investment. Furthermore, the exchange would allow for the property or asset to grow tax deferred. The Code has also not set a limitation on how many times an asset can be exchanged, allowing for an asset or property to be exchanged over and over again.

Some Rules Regarding 1031 Exchanges

When exchanging one property for another, the other property must be “like-kind.” Therefore, when exchanging one property, the other one gained must also be an accepted form of real estate. As mentioned previously, the property that is exchanged must solely be used for business or investment purposes. The individual processing the exchange cannot swap their primary residence for an investment property, and vice versa. Furthermore, there is also a time limit for this exchange. Within 45 days of the original property being sold, the exchanger must notify of the sale. Concurrently with those 45 days, the exchanger has 180 days to close the transaction on one of the designated properties for the exchange.

When exchanging property, cash must not be received as a result of the sale. If it is, then it becomes a taxable event. However, in order to avoid this outcome, those exchanging properties or assets must use a Qualified Intermediary. This intermediary must be an independent third party who is reputable and insured. They will hold the proceeds of the exchange of properties on behalf of the exchanger.