1031 Exchanges

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A 1031 Exchange is a powerful tax strategy that allows a taxpayer to defer the payment of real estate gains taxes when the proceeds are reinvested in a property of like kind. Although there is more than one way to structure a 1031 Exchange, all such transactions are strictly governed by policies and procedures set forth by the Internal Revenue Service. These regulations include such requirements as direct deeding and the use of qualified escrow accounts for the temporary holding of exchange funds, among other things. Such exchanges are available to individuals and trusts as well as C corporations, S corporations, partnerships and limited liability companies. They can include an exchange of like-kind properties exclusively or an exchange of like-kind properties together with cash and properties that are not like-kind. Although two-party exchanges are allowed, most involve the use of a facilitator known as a Qualified Intermediary.

Outlined below are some of the basic requirements of a 1031 Exchange:

  • Exchanged property must meet certain criteria.

    The properties swapped in a 1031 Exchange must have been held for business or investment purposes and must be of the same nature. Although both personal and real property can qualify as 1031 Exchange properties, partnership interests, certificates of trust and securities are specifically excluded.

  • Swaps must be structured according to set guidelines.

    All 1031 Exchange transactions are governed by exchange agreements drawn up according to the Income Tax Regulations issued by the Internal Revenue Service. While a simultaneous exchange is the simple, direct swap of two like-kind properties, deferred and reverse exchanges are somewhat more complex. The deferred exchange involves the relinquishing of one property and the subsequent acquisition of a replacement property as dependent parts of the same transaction, usually through the services of an exchange facilitator. As the name implies, events occur in the opposite order in a reverse exchange. A replacement property is acquired and held by an exchange accommodation titleholder until the relinquished property is sold to close the deal.

  • Time constraints must be met.

    There are two important time constraints associated with 1031 Exchanges. The first is that potential replacement properties must be identified in writing within 45 days from the sale of the relinquished property. This written identification must be signed and delivered to either the seller of the replacement property or the Qualified Intermediary assisting with the transaction. The second constraint is that the final exchange must be completed within 180 days from the date of the initial sale or by the income tax filing deadline for the year in which the original property was sold, whichever comes first.

Although 1031 Exchanges are a very useful tool in the managing of real estate gains taxes, they are best carried out with the help of a competent professional who understands the rules and regulations that govern such transactions. Such individuals are familiar with the reporting procedures required for 1031 Exchanges and know how to correctly track and adjust the cost basis in order to comply with IRS regulations. Knowledgeable representation is especially important in the case of 1031 Exchange transactions because, when the rules and time constraints are not strictly adhered to, the taxpayer participating in the transaction may be held liable for the very taxes that the exchange is designed to avoid.

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