What is a 1031 Exchange?
A 1031 Exchange is a transaction in which a taxpayer is allowed to sell one property and buy another without a tax consequence. This can be done through a Simultaneous or Delayed 1031 Exchange. The transaction is authorized by Section 1031 of the IRS code. It may be the best strategy for the deferral of capital gains tax that would ordinarily arise from the sale of real estate. This however may not be the best strategy for real estate investors who are selling properties for liquidity purposes as the proceeds from the sale are earmarked for a real estate purchase.
A successful exchange results in the taxpayer being able to utilize100% of the proceeds from the sale of property to purchase a new property thereby deferring the capital gains taxes.
Real Estate owners can accomplish a variety of investment objectives with 1031 Exchanges including greater leverage, diversification, potentially improved cash flow, geographic relocation, and/or property consolidation
HOW DOES IT WORK?
A 1031 Exchange is usually a three-way delayed exchange, in which an intermediary is used to facilitate the transaction. There are four basic steps:
- Seller arranges for sale of property and includes exchange language in contract;
- At closing, sales proceeds go to a Qualified Intermediary (a legal entity set up for this purpose) for a 1031 Exchange;
- Seller must identify potential exchange properties within 45 days of the closing;
- Seller must complete 1031 Exchange within 180 days of closing.
In doing a 1031 Exchange it is advisable to consult both your tax accountant and also a real estate attorney who specializes in 1031's.