1031 Tax Deferred Exchange Information

A 1031 exchange (tax-deferred exchange) is one of the most powerful tax deferral strategies remaining available for taxpayers. Taxpayers should never have to pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property. Remember that the like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

Anyone involved with advising or counseling real estate investors should know about tax-deferred exchanges, including Realtors, lawyers, accountants, financial planners, tax advisors, escrow and closing agents, and lenders.

1031 Exchange Benefits is the ability of a taxpayer to sell income, investment or business property and replace with like-kind Replacement Property without having to pay federal or state income taxes on the transaction. A sale of property and subsequent purchase of a Replacement Property doesn't work; there must be an Exchange.

 The benefits of exchanging v. selling

  • A Section 1031 exchange is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.
  • By deferring the tax, you have more money available to invest in another property. In effect, you receive an interest free loan from the federal government, in the amount you would have paid in taxes.
  • Any gain from depreciation recapture is postponed.
  • You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.

 

1031 Exchange Disadvantages include a reduced basis for depreciation on the Replacement Property. The tax basis of Replacement Property is essentially the purchase price of the Replacement Property minus the gain which was deferred on the sale of the Relinquished Property as a result of the exchange. The Replacement Property thus includes a deferred gain that will be taxed in the future if the taxpayer cashes out of his investment.

 

1031 Exchange Techniques. There is more than one way to structure a tax-deferred exchange under Section 1031 of the Internal Revenue Code. However, the 1991 “safe harbor” Regulations established procedures which include the use of an Intermediary, direct deeding, the use of qualified escrow accounts for temporary holding of "exchange funds" and other procedures which have the official blessing of the IRS. Therefore, it is desirable to structure exchanges so that they can be in harmony with the 1991 Regulations. As a result, exchanges commonly employ the services of a facilitator known as a Qualified Intermediary.

 

1031 Exchanges  Intermediary when parties to an exchange are willing to exchange deeds or if they are willing to enter into an Exchange Agreement with each other. However, two-party exchanges are uncommon since, in the typical Section 1031 transaction, the seller of the Replacement Property is not the buyer of the taxpayer’s Relinquished Property.

 

Time Restrictions On Completing 1031 Exchange. A taxpayer has 45 days after the date that the relinquished property is transferred to properly identify potential replacement properties. The exchange must be completed by the date that is 180 days after the transfer of the relinquished property, or the due date of the taxpayer's federal tax return for the year in which the relinquished property was transferred, whichever is earlier. Thus, for a calendar year taxpayer, the exchange period may be cut short for any exchange that begins after October 17th. However, the taxpayer can get the full 180 days, by obtaining an extension of the due date for filing the tax return.

 

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