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Introduction to 1031 Exchanges

If you are considering the sale of investment real estate, it is important to consider a 1031 tax-deferred exchange. A 1031 exchange allows you to defer capital gains, depreciation recapture and investment taxes, while reinvesting the entire proceeds into other investment real estate. However, there are strict rules and timelines that must be followed.

Brief History

Brief History

The basis of the 1031 exchange lies in the idea that when an investor reinvests proceeds in a replacement property it is a continuation of the original investment. Because all sale proceeds are reinvested, it would be unfair to ask the taxpayer to pay taxes with unreceived cash.

It is important to note that the tax obligation is deferred—not eliminated.

Historical Dates: 

1921 - The 1031 was first authorized as part of the Revenue Act of 1921. 

1935 - First modern tax-deferred exchange using a Qualified Intermediary

1954 - Section 112(b)(1) changed to Section 1031

2002 - Tenants in Common (TIC)

2004 - Delaware Statutory Trusts (DSTs)

What is a 1031 Exchange?

What is a 1031 Exchange?

Section 1031 of the Internal Revenue Code allows an investor to defer the payment of capital gains and depreciation recapture taxes that may arise from the sale of investment real estate. By using the proceeds of this sale to acquire “like-kind” real estate, taxes may be deferred, as long as the investor meets certain conditions and deadlines.

Exchange real property for like-kind real estate and use all of the proceeds for the purchase of replacement property 

Like-kind real estate includes business/investment real property (not primary residence)

Section 1031 does not apply to the exchange of stocks or bonds

Acceptable Like-Kind Exchanges

“Like-Kind” - A property similar in nature or character, regardless of differences in grade, property type, or quality. Both the Relinquished and the Replacement Properties must be held by the Exchanger either for investment purposes or for productive use in trade or business.

Our Process
Our History
Our Values
Our Resources
Our Process
Our History
Our Values
Our Resources

Which Real Estate Interests Qualify for an Exchange?

Interests That Qualify

  • Fractional (tenancy-in-common) interest
  • Leasehold interest, 30-year plus lease
  • Water rights
  • Mineral Rights
  • Oil & gas interests
  • Rental homes
  • Business properties
  • Farmland

Interests That Don't Qualify

  • Personal residence
  • Land under development for resale
  • Construction or fix/flip for resale
  • REITs
  • Partnership Interests

Rules to performing a 1031 Exchange

To successfully complete an exchange and defer capital gains taxes, investors need to satisfy the following requirements:

WHAT, WHEN, & HOW


WHAT - Replace the Value, the Equity, and the Debt

*We assist our clients in finding appropriate investment solutions that satisfy these requirements.


WHEN - An exchange must be completed within 180 days of sale. 

HOW - Three Options to identify Replacement Properties.

*We always assist our clients in completing the identification form so it can be submitted to their QI quickly and accurately.

The 1031 Exchange Process

What is a Qualified Intermediary (QI)?

What is a Qualified Intermediary (QI)?

A Qualified Intermediary plays a pivotal role in all stages of the process, including:

  • Incorporates 1031 Exchange language into the investment sale contract prior to closing.
  • Completes Escrow/Trust account setup. Proceeds from the relinquished property sale are sent directly to the escrow/trust account.
  • Manages timeline — 45-day and 180-day rules.
  • Identifies replacement property and ensures requirements are met.
  • Executes final transfer of 1031 proceeds from Escrow/Trust account to fund replacement properties.
  • May also provide in-house legal and tax teams to provide additional support.

For references or introduction to our QI partners, please let us know.

Benefits of Performing a 1031 Exchange

TAX COMPONENTS – To appreciate the benefits of a 1031 exchange, it’s important to understand the tax components.In a 1031 exchange, capital gains, depreciation recapture, and net investment income taxes on the sale of a property are deferred.

This makes the 1031 Exchange potentially the single most important tax strategy for preserving and growing the value of your real estate investment.

 

DIVERSIFICATION – Repositioning Your Real Estate Portfolio:

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