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1031 Tax Deferred Exchange

1031 Defined

1031 is a section of the IRS tax code that is geared specifically for the real estate investor.  Simply put, this tax code states that if you sell a piece of investment real estate, and purchase another piece of investment real estate of equal or greater value, you defer the capital gains taxes, any applicable state taxes, and any depreciation recapture taxes.

All Real Estate Can Be Exchanged

One of the common misconceptions that many people have is that they must purchase the same type of property as what they are selling. This could not be further from the truth. All real estate can be exchanged.

For example, you could sell a residential rental unit and exchange it for an office complex. Another example would be a client selling vacant land in exchange for a commercial building. The rule of thumb is, if it can be deeded, it can be exchanged.

Five Key Points Regarding A 1031 Exchange

There are basically five key points to keep in mind when doing a 1031 exchange:

  1. In order to ensure that you defer all of the taxes on the sale of your relinquished property, you must spend an amount equal to your net selling price. (NSP = Selling Price less Closing Cost)
  2. You must use a Qualified Intermediary (QI) to facilitate the exchange.  The QI must be an independent third party.  It cannot be your Accountant, Realtor, Attorney, or anyone who has a fiduciary relationship with you.  The role of the QI is to prepare the exchange documents, escrow the proceeds, and coordinate will all involved parties to ensure that the exchange is performed according to IRS guidelines.
  3. All properties involved in the exchange must be investment property.  In other words, they cannot be a primary or second home.  They must be properties that are held for investment or business use.  
  4. You must identify up to three possible replacement properties within 45 days of closing on the sale of your relinquished property.  Only the properties identified as of the 45th day will qualify for your 1031 exchange.
  5. You have a total of 180 days from closing on the sale of your property to complete the exchange.  You must close on all intended purchases by the 180th day.

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