1031 Like-Kind Exchanges in Real Estate
An elementary introduction to the potentially lucrative real estate investment mechanism known as the "1031 like-kind exchange".
What is a 1031 "like-kind" exchange?- Section 1031 of the Internal Revenue Code allows you to postpone paying tax on the gain (profit) from the sale of property, if you reinvest the proceeds in similar ("like-kind") property as part of a qualifying like-kind exchange.
- Any gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.
Why use 1031?Grants the taxpayer more buying power to invest in additional property, because there is no need to deduct funds to pay taxes.
Deferred income (from later sale) may be taxed at a lower rate if the taxpayer's income is less at the time that income is calculated.
Possibility of avoiding tax at all, if acquired property is passed to heirs and heirs take property with a stepped-up basis.
How does a 1031 exchange work?Know the two year, forty five day, and 180 day rules.
Two Year Rule:
The property that is being sold in order to buy a "like-kind" property is called the "Relinquished Property." In order to qualify for a 1031 exchange, the relinquished property must have been owned for at least two years, and it must have been an investment or an income-producing property. The "replacement property" (the property purchased with the proceeds of the sale of the relinquished property) must also be an investment or an income-producing property. Replacement property does not have to be the exact same kind of property, as long as it shares the characteristic of being an investment or income-producing.
45 Day Rule:
Replacement property can be identified before the sale of the relinquished property, but it must, at the very latest, be identified within 45 days of the sale of relinquished property. Written notice adequately identifying the property must be signed by the taxpayer and mailed to a qualified person within the 45 day period.
180 Day Rule:
The taxpayer must "close" the purchase of the replacement property within 180 days of the sale of the relinquished property.
Qualified IntermediaryQualified Intermediary: The taxpayer in a 1031 exchange can never have possession or constructive possession of the proceeds of the sale of the relinquished property. In other words, the taxpayer cannot receive the proceeds, and the proceeds cannot be received by anyone that is not a qualified intermediary. This means that an "Intermediary" is required for every 1031 exchange. An intermediary can be any individual or entity who is unrelated and without a pre-existing or ongoing relationship with the exchanger.
Always use an experienced, licensed, bonded, and insured intermediary company, such as Old Republic Exchange www.orexco1031.com.
Don't go it alone!
A 1031 "like-kind" exchange can be a great way to manage your tax obligations on real estate investments and maximize available investment dollars. They do, however, require the expertise of professionals to insure that all of the legal requirements are met in a proper, timely manner. Anyone considering a 1031 exchange is encouraged to retain professional guidance at the earliest stage of planning.
Please note that this guide is intended to familiarize the reader with the basic framework and purpose of a 1031 exchange. It is not intended to provide specific legal advice. Anyone planning on engaging in a 1031 "like-kind" exchange should consult an attorney, tax adviser, and a licensed, bonded, and experienced 1031 exchange intermediary company.