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The 1031 Tax Exchange

- An Overview

Section 1031 of the US Internal Revenue Code allows owners of real estate to defer capital gains if they exchange into like kind properties. The requirements of Section 1031 are specific and must be met to realize this "tax free exchange".

General Requirements

  • The exchange must be "like-kind" property. ( Properties are of like kind, if they are of the same nature or character, even if they differ in grade or quality. Real properties generally are of like-kind, regardless of whether the properties are improved or unimproved. However, real property in the United States and real property outside the United States are not like-kind properties.)
  • You have 45 days to identify your replacement property. ( you can identify More than the property you will exchange to, It's the VALUE that's significant, & you can exchange into several pieces from one)
  • You have 180 days to close on your replacement property. The title must pass from the seller to the taxpayer within the 180 days.
  • The title on the replacement property must mirror the title on the relinquished property. It should be noted there are some exceptions.
  • The replacement property must be greater than the relinquished property. Any monies received from the sale of the relinquished property and not reinvested in the replacement property are considered boot and is subject to taxation. Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like kind exchange under IRC Section 1031 is tax deferred, but it is not tax free.
  • A reverse exchange or also known as reverse starker exchange or reverse exchange, is somewhat more complex than a deferred exchange. It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.
  • Taxpayers should be wary of individuals promoting improper use of like-kind exchanges. Typically they are not tax professionals. Sales pitches may encourage taxpayers to exchange non-qualifying vacation or second homes. Many promoters of like-kind exchanges refer to them as “tax-free” exchanges not “tax-deferred” exchanges. Taxpayers may also be advised to claim an exchange despite the fact that they have taken possession of cash proceeds from the sale.

Consult a tax professional or refer to IRS publications listed below for additional assistance with IRC Section 1031 Like-Kind Exchanges.

References/Related Topics

The application of Section 1031 in relation to a specific property can only be determined after the revenue of a taxpayer facts and circumstances from an attorney, financial analyst, tax advisor, or intermediary. 

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