What Is a 1031 Tax-Deferred Exchange?
A 1031 Exchange is a method of selling one property and then buying another within a specified time frame, while accessing certain tax advantages. While the processes of selling one property and buying the next are very similar to standard sales and purchases, the overall transaction is treated as an exchange. This allows the taxpayer to qualify for a deferred gain tax status, because sales are taxable by the IRS while exchanges are not.
The rules regarding a 1031 Exchange are listed by the IRS under Like-Kind Exchange Regulations. Therefore, a property owner or investor should consider a 1031 Exchange when he or she expects to purchase a “like-kind” property following the sale of an existing property. Otherwise, capital gains taxes may be due on the sale of the first property.
A 1031 Exchange is a complicated procedure, and is subject to many rules. In order to initially qualify, however, a transaction must meet two basic qualifications:
- The total purchase price of the replacement “like kind” property must be equal to, or greater than the total net sales price of the relinquished property.
- All the equity received from the sale of the relinquished real estate property must be used to acquire the replacement, “like kind” property.
If the transaction qualifies as a 1031 Exchange, the proceeds from the sale must be handled through a qualified intermediary. All cash proceeds from the sale must be applied toward the new purchase, or else any proceeds retained by the seller will be taxable. In addition, the newly-acquired property must be subject to the same or greater level of debt as the property just sold. If the property does not qualify in this way, the owner may be taxed on the amount of decrease in debt. The time line governing 1031 Exchanges involves an Identification period and an Exchange period. Each of these periods in the overall process are quite restrictive, and precise rules must be followed at all times.
Consultation with an experienced real estate attorney will help the property owner to recognize the benefits of a 1031 Exchange, and the attorneys of Larson & Solecki can refer you to an accommodator who can handle the exchange, or to a tax attorney for more detailed planning.