What is a 1031 Exchange?

If one of my commercial properties gets bought out this month, it would generate a significant profit - as well as the corresponding significant tax payments to Uncle Sam. So I have contacted my good friends at McFerran & Burns to discuss one of the two most common methods for deferring capital gains taxes on the sale of property: a 1031 Tax Deferred Exchange.

IN IT’S SIMPLEST TERMS a 1031 Tax DeferredExchange is a method of deferring the capital gains tax paid by an investor as real property is purchased and sold. The tax code permits a taxpayer to exchange property held for a productive use in a trade, business or as an investment for a property of a like-kind without recognizing income, therefore delaying taxes.

One of the best reasons for using this tool is by deferring the tax you are able to reinvest all the cash and equity. This opens the door to many options: property with higher revenues, relocation of investment properties, higher appreciation, increased or decreased actual properties as suits. Essentially it allows the investor to craft their business in manner that suits them best.

Here are some general rules related to a 1031 Exchange:

EXCHANGE must be completed within specific timelines, or capital gains tax is reinstated.

A QUALIFIED INTERMEDIARY is required to ensure Exchangor doesn’t have control over sale proceeds during exchange

EXCHANGE AGREEMENTS must be in place between correct parties on strict timelines

CASH FROM EXCHANGE can only be withdrawn at 4 limited times during the exchange

LIKE-KIND PROPERTY means “productive” investment real property rather than stocks and bonds, and not property to be held only for resale.

Thanks to Kevin Hummel at McFerran & Burns for help with this blog post.

Happy Investing!