What Is a 1031 Exchange?
Section 1031 of the Internal Revenue Code (IRC) allows buyers and sellers to exchange property of equal or near value in lieu of trading money for property, which would be subject to immediate taxation. Also called like-kind exchanges, these allow owners of investment or business property to postpone capital gain taxation on new property. By doing so, investors and property owners can hang on to the entire gross equity gained through a sale and reinvest it in a replacement property. By deferring taxes on gains, investors may be able to use all gains to purchase or make a down payment on a more highly valued property.
Who May Engage in a 1031 Exchange?
According to the IRS, 1031 exchanges may be an option for various taxpaying entities, including:
- Individuals
- General or Limited Partnerships
- Limited Liability Companies
- C Corporations
- S Corporations
- Trusts
What Sort of Property May Be Traded in a 1031 Exchange?
Like-kind exchanges may only involve property which is similar in value and nature. As it pertains to real estate, this means real property (such as a home, building, or plot of land) cannot be exchanged with personal property (such as automobiles or any other movable property).
According to IRC Section 1031, you are also prohibited from offering or accepting any of the following in a 1031 exchange involving real estate:
- Bonds
- Notes
- Debts
- Partnership interests
- Inventory or stock in trade
- Certificates of trust
- Securities
- Stocks
Does Property Need to Be Traded at Once in Order to Qualify as a Like-Kind Exchange?
Deferred exchanges are permitted, but your transaction must be completed within strict time limits set forth in Section 1031. (National disasters as declared by the president are the only circumstances which would warrant forgiveness of failure to comply with these limitations.)
If your 1031 trade involves delayed receipt or delivery of a replacement property, there are 2 critical deadlines you must meet in order for your transaction to be considered a legitimate like-kind exchange:
- Within 45 days, you must officially identify possible replacement properties. You must sign a written identification and deliver it to the owner of each potential replacement property or their official representative (such as a realtor or attorney).
- Within 180 days or before the income tax return due date for that year, you must relinquish or receive the replacement property in question. This property must be similar to the potential replacement properties initially identified in the first 45 days.
