Tax-deferred Exchanges - 1031 Exchanges
A 1031 exchange, pursuant to the Internal Revenue Code, Section 1031, allows an owner (also referred to “taxpayer”) to sell real property and reinvest the proceeds of the sale into new ownership of like-kind property and defer the capital gains taxes. It is a deferment of taxes, even though persons refer to a “tax free exchange”. There is no tax on the exchange, but the owner keeps the same tax basis. To qualify, the exchange must be done in strict accordance with 1031 rules and code.
All of the sales proceeds, after full payment of closing costs and mortgages, if any, must be paid to the third party Qualified Intermediary (QI). No proceeds may be paid to the selling owner. The QI is an entity that can legally hold funds to facilitate the 1031 exchange. The QI is essential and mandatory to complete a successful 1031 exchange.
Some of the exchange rules are that (i) the property must be like-kind and held for trade, business or investment purposes, (ii) proceeds must be in the hands of the QI and never in the owner hands, (iii) all cash proceeds must be reinvested in the replacement property, and (iv) the replacement property must be subject to an equal or greater debt than the sold or relinquished property.
Lastly, there are the 1031 timelines, and these are extremely important. First, there is the identification period, which is 45 days. This requires the owner/taxpayer of the relinquished property to identify suitable replacement properties within 45 days. The 45 days commences on the sale/closing date and ends 45 days thereafter and there is no extension for holidays or weekends. Next there is the exchange period. It is 180 days (from the taxpayer’s transfer of the relinquished property) or the taxpayer’s tax return filing date (unless extended) whichever is the shorter and like the 45 day rule there are no extensions.