The term 1031 Exchange refers to section 1031 of the IRS Code which allows investors to “defer” payment on capital gains taxes, specifically those related to the sale of investment properties, so long as the profit gained from the sale of an investment property is used for the purchase of a “like-kind” property.
Although it is possible a traditional 1031 exchange where one property is literally swapped for another like kind can happen, it is very unlikely that the owner of the property you are purchasing wants the property you are selling. Most exchanges occur as three party or delayed exchanges in which a middleman holds the funds after the sale of your property and is then used to purchase the new property.
- Like-Kind Property
The definition of a “like-kind property” is very broad; the same nature or character, even if they differ in grade or quantity. As far as real estate is concerned almost any type of property can be exchanged as long as it is not a personal property.
- Investment/ Business properties only
1031 exchanges only apply to business properties, so a primary residence cannot be swapped for another primary residence.
- Greater or Equal Property Value
In order to avoid taxes the net market value and equity of the property purchased must be the same or greater than the property being sold.
- Must not Receive Excess Funds
Excess Funds are referred to as a “Boot”, the cash received is then taxed.
- Same Tax Payer
The name appearing on the title of the property being sold must be the same name that purchases the new property, an exception occurs in the case of single member LLCs.
- 45 Day Identification Window
A new property must be identified within 45 days of the closing of the first property. Up to 3 properties can be identified as like-kind.
- 180 Day Closing Window.
The closing for the replacement property must be completed with 180 days or the income tax return due date, whichever is earlier.