What is a 1031 Exchange?

A 1031 Exchange, as governed by IRC, comes as a big boon for property investors. It lets real estate owners and property business owners swap like-kind real estate property in the open market, and by following certain IRC guidelines, could save paying capital gain tax on the sale. Even though the 1031 exchange is gaining popularity among real estate owners in the US, still many property owners end up paying taxes owing to ignorance. This article attempts to clear some of the vague areas that exist in the public understanding of the concept.

In a 1031 exchange, there are certain conditions that one needs to stick to while selling or buying the property. For example, according to IRC guidelines, there must be an exchange of two pieces of like-kind real estates. In other words, a person selling a real estate property under the 1031 exchange must buy another within the stipulated time in order to claim the benefits under the IRC section 1031. He/she can’t just sell his/her property, take the money from the buyer, and sit idle. It has to be invested elsewhere.

The IRS has given two time deadlines to the investors; the first one states that the sellers, within 45 days of closing the sale of the old property, must identify a new property to purchase. The exchanging parties can shortlist a minimum of three prospective replacement properties. The second deadline mandates that within 180 days of closing the sale of old property, the investor must have bought the exchange property as well. Meeting these two deadlines makes one’s property exchange a valid one under 1031.

The second condition under 1031 exchange that every property exchanger must adhere to is that the two real estates exchanged must be of a like-kind. Not to misinterpret the term, ‘like-mind’ under section 1031 refers to the usage of the properties, and not their grade or quality or modifications effected to its structure at any point in time. Therefore, it is obvious that any property that has been used for trade, business or investment purposes only qualify under section 1031. Apartments, if were rented out to tenants and was not used for personal purposes, would also qualify for tax deferrals under provisions of 1031.

Investors can purchase/sell more than one property at a time under the provisions of IRC section 1031 provided both are like-kind, and the entire money obtained from the sale are utilized to buy replacements. The money, if any, left behind after completing the deal qualifies for capital gain taxing. However, residential flats and dealer properties do not qualify under 1031 exchange. Also, non real estate entities such as inventory, notes, bonds, securities, stocks, debentures, etc are excluded from the purview of section 1031.