1031 Tax Exchange – What Is It?

     A 1031 tax exchange, also known as 1031 exchange, is a simple method for avoiding capital gains taxes on a sold investment property until a further date. 1031 refers to section 1031 of the Internal Revenue Service code that says that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment.
     A 1031 tax deferred exchange is a method where a property owner trades one or more properties for another like kind of property. It is a way to sell one property that is qualified within a certain time period. The framework and the process of selling a property and then purchasing another property are similar to any standardized sale and purchase situation. A 1031 exchange is unique because the entire transaction is treated as an exchange and not as a sale or a taxable event in the eyes of the IRS. A 1031 tax deferred exchange allows an individual or entity to qualify for a deferred gain tax treatment. There are three critical steps to a 1031 exchange.

Declare With Qualified Intermediary Intent To Use 1031 Exchange in Sales Contract
     It is critical to declare that you will be engaging in a 1031 exchange in a purchase contract before the closing. After a piece of property closes it is too late to change the status. You must use a Qualified Intermediary to receive the net proceeds at the closing and to hold the money until you close on the new investment property.

Identify Within 45 Days 3 Replacement Properties
     In the IRS tax code section 1031, you are required to identify the replacement property with 45 days following the sale of the relinquished property. You may identify no more than three properties as potential replacement properties. It is possible to have more but it is subject to certain restrictions. It is recommended that you go over multiple tenant in common properties if only to identify as back up properties. You just want to make sure that you have a back up in case your top choice does not close. Not identifying multiple replacement properties is one of the biggest reasons a 1031 goes south. When a 1031 exchange goes bad, guess what you will be doing? You guessed it, you will be paying your capital gain taxes to Uncle Sam.

Purchase Replacement Property Within 180 Days
     You have 180 days to obtain the replacement property after the original sale of the relinquished investment property. The qualified intermediary pays the closing costs and you receive the deed to the replacement property. One stipulation for deferring taxes with an exchange is that the replacement property that you select must be of equal or greater value than the relinquished property. Many real estate investors are not clear on the 1031 exchange process. Make sure that you use a real estate broker that is experienced with doing a 1031 exchange of property.
     With the increase of real estate speculation in recent years in tenant in common property and the amount of money in the market, tax deferment has become an essential vehicle for the savvy real estate investor to leverage their assets. It used to be that real exchanges were a foreign topic for many investors, but today it is commonplace for real estate investing. I hope this was a valuable article for you. My goal was to save you thousands in taxes in using the 1031 exchange to help your real estate investment portfolio grow.