Tax Deferred 1031 Exchange

Generally, when you sell real estate, you have to pay tax on the gain from the sale of your property. This gain is caused either by the property appreciating over time or by taking depreciation deductions for tax purposes. Section 1031 of the Internal Revenue Code allows you to defer paying that tax.

A 1031 Exchange is not a tax loophole. It is a code section written by Congress specifically to allow anyone who meets its requirements to sell their property and defer paying tax on the gain. For example: The Investor (exchangor) must have a like kind investment property to do the exchange. i.e., Investment rental property for another investment rental property or Investment vacant lot for investment rental property, etc.

The exchangor should purchase a property for a higher basis than the selling property to get the best results. The exchangor as purchaser can leverage their investment by financing and receiving cash at settlement and gaining additional tax incentives.

The exchangor also needs to select an attorney experienced with completing the exchange documents that are needed. The cost of this service ranges from approximately $700 to $1,000.

For real estate, like kind refers not in the nature or quality of the property, but to the underlying definition of real estate under state law. If a property meets the definition of real state under state law, that property is like kind to a property in another state defined as real estate. (Personal property rules are much, much more complex.)

The Value/Debt/Equity Calculations

If a fully tax deferred exchange is the goal, the following rules must be strictly adhered to:

The value of the replacement property must be equal to or greater than the value of the relinquished property.
The debt on the replacement property must be equal to or greater than the debt on the relinquished property.
The equity in the replacement property must be equal to or greater than the equity in the relinquished property.

Exception to the Value/Debt/Equity – Debt reduction (Debt relief) can be offset by additional funds invested by the exchanger.

The 45/180 Day Requirement

The property to be received must be identified within 45 days of settlement (transfer) of the relinquished property.
The received property must be settled (transferred) within 180 days of the settlement date of the relinquished property.

These date are strictly enforced.

Identification Rules

Rule 1 – Any Property closed on within the 45 days is automatically considered identified.

NOTE: Please seek competent accounting and legal advice prior to entering into a tax-deferred exchange.