1031 Exchanges in Real Estate

The 1031 Exchange is commonly used by real estate investors to defer taxes on gain in the sale of a home. This type of sale, more commonly known as the "Like-Kind" Exchange, can be utilized in transactions involving business or investment properties. Derived from the Internal Revenue Service's code Section 1031, the exchange is described as such:

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."

In other words, an investor can postpone the tax consequences of selling their property when purchasing another property for the same use. There are specific guidelines which should be followed to qualify the sale for a 1031 Exchange. Investors are encouraged to seek legal and tax advice prior to beginning the process.

The 1031 Exchange can be completed in several manners. In one method of completion the investor will close on their relinquished property and immediately after close on their replacement property. This process is completed in one business day and is referred to as a simultaneous exchange. An investor may or may not use a qualified intermediary to handle the funds, although it is not required.

Another method allows the investor to close on the relinquished property, then identify and close on the replacement property within a certain number of days. This type of exchange is referred to as a deferred exchange and requires a qualified intermediary. The qualified intermediary is an uninvolved third party who holds the funds in escrow since the rules to an exchange disallow the investor from having access to the funds in interim. The identification period in this method is 45 days from the closing on the relinquished property. At this point the investor may identify up to 3 properties or 200% of the market value of the relinquished property. The replacement property, or properties, must then close within 180 days of the closing for the relinquished property.