What Is A 1031 Exchange In Plain English?

I had no idea what a 1031 exchange was when I first heard of it, but have since learned some more about it. This article is intended to help others who have no idea what a 1031 exchange is, but would like to know. I will do my best to write this in a clear, easy to understand manner.

Before you can understand how a 1031 exchange works, you should first understand why they exist. They exist so that people can avoid losing money in form of capital gains tax when they sell one property with the intent to reinvest the proceeds immediately. A 1031 exchange makes it possible to defer the capital gains taxes. The term 1031 actually comes from the IRS code. The reason this was created was to encourage people to continue to reinvest their profits, thus helping the economy.

Now that you understand the reason for a 1031 exchange let's talk about the workings of a 1031 exchange. To get started, you will need to hire a professional QI (Qualified Intermediary). It is required by the law. These are companies that are an independent 3rd party whose job it is to make sure that you follow the rules. They also hold the gain from the sale of the original property until you reinvest it into the replacement property.

There are certain things that will qualify and what will not qualify for a 1031 exchange. 1031 exchanges involve the sell and purchase of property. Most typically, this refers to property like single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities. There are specific exclusions from 1031 exchanges, such as stocks and bonds. You should ask your QI about other exclusions before making any decisions on a 1031 exchange.

One of the main factors is that the properties need to be of like kind. Like kind is referring to the nature or characters of properties, not the grade or quality. Another factor in 1031 exchanges is that the properties must be held for productive use in trade or business or for investment.

The 1031 in 1031 exchanges actually comes of the Internal Service Revenue code. Keep that in mind because there are a lot of rules and regulations about how you can and cannot use a 1031 exchange. While it is always advisable to seek the guidance of a professional pertaining to your circumstances, there are some general guidelines that can help you understand the basics.

1- The value of the acquired property must be equal to or greater than the value than the relinquished property.
2- The equity of the acquired property must also be equal to or greater than the value of the relinquished property.
3- The debt on the acquired property must be equal to or greater than the debt of the relinquished property.
4- ALL of the net profits from the relinquished property must be used to acquire a new property.

There are also some timeline issues that you will want to be aware of. First, in order to successfully qualify for a 1031 exchange, you will need to identify a new property by the 45th calendar day from the time of the closing on the relinquished property. (There are guidelines about that too - see a professional) Second, you need to close on the new property by the 180th calendar day from the time of the closing on the relinquished property. Hopefully this helps. Please call a professional when you are getting ready to consider a 1031 exchange.