* Information on this page is presented by Legal 1031 Exchange Services, Inc.
I. What is an 1031 Tax Deferred Exchange?
An 1031 tax deferred exchange allows owners of real or personal property to defer the recognition of a capital gains tax they would have recognized when they sold their property. Exchanging allows investors to reinvest money into new business or investment properties that would otherwise have been paid to the government as a capital gains tax.
- Property must be held for investment or for use in a trade or a business
- Property must be exchanged for like kind
II. "Like-Kind" Property
One of the most misunderstood concepts of tax deferred exchanges is that of “like-kind.” Many people mistakenly believe that it means the same type of property must be purchased when completing an exchange. Nothing could be further from the truth. Exchangers can sell one type of property and buy a completely different type of property. In order to qualify as “like-kind,” the property must be held for productive use in a trade or business, or for investment purposes.
What this means is that Exchangers have the opportunity to purchase replacement property of any type. For example, an Exchanger can sell vacant land and buy a strip mall, or sell an apartment building and buy an industrial complex. Although 1031 exchanges are governed by federal law, state law determines what is, and is not, real property. Therefore, exchanges of real estate interests such as air rights, easements, timber, conservation easements, and development rights may be possible. The graphic below illustrates how all property held for business or investment purposes is “like-kind” to all other property held for business or investment purposes.
III. 1031 Exchange Process
- The Exchanger will retain a Qualified Intermediary to prepare the necessary documentation.
- When the closing is consummated, the proceeds are delivered directly to Legal 1031 Exchange Services as the Qualified Intermediary.
- The Exchanger must identify the replacement properties within 45 days following the sale of the relinquished property.
- Identification Rules:
- 3 Property Rule: 3 properties without regard to their market value.
- 200% Rule: any number of properties so long as the aggregate FMV does not exceed 200% of the relinquished property.
- Exchanger must acquire the replacement property by the earlier of 180 days following the sale of the relinquished property or the date the taxpayer must file its tax return (including extensions) for the year of the transfer of the relinquished property.
- All proceeds received from the sale of the relinquished property must be used toward the purchase of the replacement property, or pay tax on the difference;
- The replacement property must be of equal or greater value as relinquished property you sold, or pay tax on the difference;
- The entity that sells the relinquished property must be the same as the entity that acquires the replacement property;
- Must use a Qualified Intermediary - Legal 1031 Exchange Services.
Courtesy of Legal 1031 Exchange Services, Inc.