What is a 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 either caused by the property appreciating over time or by taking depreciation deductions for tax purposes.

With a 1031 Exchange, when you sell business or investment real estate, you can defer the payment of the tax that is normally due on the sale.

Anyone who is thinking about selling a business use or investment property should consider affecting a 1031 Exchange. An Exchange offers the astute investor an opportunity to reinvest the federal capital gains that would normally be handed over to the IRA and put that money to work for himself.

Essentially, 1031 Exchanges should be thought of as an interest free loan from the IRS; one in which the principal may be increased through subsequent exchanges and may never require repayment, if you plan properly.

Advantages of Exchanging

1. The Exchanger will have more buying power because the federal income taxes are deferred. This will enable him to leverage himself up greater than he could have he paid the tax liability. The additional equity to reinvest will make him a more solid buyer and help him get easier financing.
2. Investors can do exchange after exchange to create a pyramiding effect. This tax liability is forgiven upon the death of the investor as the heirs get a stepped up basis on the inherited property.
3. The Exchanger will have greater selling power because he does not have to inflate the sales price to try to cover some of the capital gains that would normally be due upon the sale of an investment property. It will enable him to be more flexible with the selling price.
4. The Exchanger can acquire a replacement property with greater income potential. He can sell raw land and acquire income-producing property. Perhaps, he wants to acquire a building with additional units or in an easier to rent location.
5. The Exchanger has the opportunity to consolidate several hard to manage properties in one easy to manage property or diversify several small properties into one large property. It provides an excellent opportunity to relocate or expand a current business or investment.
6. An exchange can also help an investor acquire a less management intense property.
   

Six Things You Need to Know About 1031 Exchanges

1. The old property and the new property must be either land or investment property. If your properties pass this test, you can exchange any type of real estate for any other type of real estate.
2. From the date of closing on the old property, you have 45 days to determine a list of properties you want to buy.
3. Also, from the date of closing, you have 180 days to close the purchase of one or more of the properties listed on your 45-day list.
4. You cannot touch the money. By law, the money is held by a Qualified Intermediary (also referred to as an Accommodator). You cannot leave the proceeds in escrow until the second property is acquired, nor can you have a friend, employee, broker, or even your CPA or attorney hold the money for you.
5. Whoever is on the title of the old property has to remain on the title of the new property.
6. To not have any taxable gain, you must reinvest all your cash proceeds and buy a property of equal or greater value.