1031 Tax Deferred Exchange Basics

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"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment."

Purpose: to defer taxation on the sale of real property by buying another parcel of real property and using the funds from the the first sale to buy the second property.

- capital gains tax is deferred (20%)

- the sold property and the bought property must be investment property

- must within the United States

- can be multiple properties

How its done: its done through a Qualified Intermediary who facilitates the transactions by holding the funds from the sale of the first property (relinquished property) until the second property (replacement property) is identified and purchased.

- replacement property must be identified within 45 days of relinquished property sale

- up to 3 replacement properties can be identified (only 1 of the 3 need be bought)

- closing after the sale of the relinquished property must take place within 180 days

- trade must be even or up. Anything below will be taxed.

Identified Property:

  1. Three properties without regard to their fair market value (3 Property Rule);
  2. Any number of properties so long as their aggregate fair market value does not exceed 200% of the aggregate fair market value of all relinquished properties (200% Rule);
  3. Any number of properties without regard to the combined fair market value, as long the properties acquired amount to at least ninety five percent (95%) of the fair market value of all identified properties (95% Rule).

Example: Assuming in your 1031 Exchange you sell your relinquished property for $400,000 (and your basis in that property is $100,000), the purchase price of your replacement property must be at least $400,000 or else you will be taxed on the amount of money less than $400,000. Upon completion of the 1031 Exchange no Capital Gains taxes will be due.

Qualified Intermediary’s job: obtaining necessary information, preparing the Exchange Agreement, assignment forms, replacement property identification form and other paperwork, dealing with the closer who is handling the closing of the sale of Relinquished Property, obtaining the funds to be escrowed, dealing with the closing agent who is handling the closing of the purchase of Replacement Property including delivering funds to the closing agent, etc.