1031 Exchange Frequently Asked Questions
What is a 1031 tax-deferred exchange?
Section 1031 of the Internal Revenue Code allows property owners to defer capital gains taxes on the sale of investment property by exchanging qualified, real or personal property (relinquished property) for qualified, like-kind property (replacement property).
What are the tax advantages in a 1031 exchange?
By deferring the recognition of the capital gains tax, the property owner has substantially more proceeds to purchase a replacement property. Also, by selling one property and buying another at a higher price, you will gain additional depreciation deductions, which can often act to increase your after-tax income. In addition, in many instances you can defer paying taxes on the recapture of depreciation incurred on the property.
What is meant by "like-kind" property in a 1031 exchange?
For real property exchanges, the like-kind requirement dictates that both the relinquished and the replacement properties have to be property that is used in a trade or business or held for investment. For example, apartment buildings may be exchanged for raw land or a warehouse can be traded for a self-storage facility. Basically, any sort of real may be swapped for any other property so used or held that qualifies as real estate under local law (i.e., the law of the state in which the replacement property is located).
Can I sell or buy multiple properties in a 1031 exchange?
Yes. Property owners can exchange multiple smaller properties for a larger one and vice versa. The key in a 1031 exchange is to always "trade up" in value in order to maximize the amount of capital gains taxes that are deferred.
Are their time restrictions on a 1031 exchange transaction?
Yes. Under a delayed or "Starker" exchange, there is a 180-day time span in which the 1031 exchange must take place. Also in a Starker exchange, the replacement property must be identified within 45-days of the sale of the relinquished property.
How can I defer the maximum amount of capital gains tax in a 1031 exchange?
The main rule is that the replacement property being purchased must be equal or greater in value to the relinquished property being sold. Basically, all of the equity from the relinquished property must go into acquiring the replacement property with the same or a greater level of debt.
What is a Tenancy-in-Common (TIC) Structure?
A tenancy-in-common is a form of real estate ownership, where two or more individuals each own a fractional share of a whole piece of property. In 2002, the IRS released Revenue Procedure 2002-22, which significantly increased the use and attractiveness of the TIC structure. Revenue Procedure 2002-22 sets forth a series of guidelines which, if complied with by a sponsor or a TIC investment program, would allow the sponsor to seek and obtain a favorable tax ruling that the TIC interests created by the sponsor would be deemed "like kind" property for purposes of section 1031 and, therefore, qualify as replacement property necessary to accomplish an exchange.
What is a Qualified Intermediary and must I use one in a 1031 exchange?
A Qualified Intermediary (QI), also called an accommodator, is a third-party that facilitates a 1031 exchange and is required by the IRS. The IRS does not allow your accountant, attorney, or escrow company to act as the QI. You must contact a QI before selling property that you wish exchange under section 1031.
Material on these pages is intended for informational and educational purposes only. Please consult with legal counsel and other qualified advisors before initiating any real estate transaction. The material contained herein does not constitute an offer to sell or a solicitation of an offer to buy any security.