What's a 1031 Exchange?

A tax deferred exchange under Section 1031 continue to be a sensible and cost effective way of deferring tax on capitol gains on your real estate/investment properties.  To qualify for tax deferment under I.R.C. Section 1031, the taxpayer must exchange property held for productive use in a business or trade, or held for investment for a "like kind" property also to be held for productive use in business or trade or held for investment purposes.  A commercial building, bare land, a mall, apartment building and rental house are just a few examples of the types of properties that may qualify.   An exchange can be a simple swap of property, a simultaneous exchange or a delayed exchange. 

To qualify for tax deferral, the taxpayer must trade or exchange his or her Section 1031 property following the terms of an integrated plan (exchange agreement) structured to effect the exchange of like-kind properties.  An agreement to sell and a subsequent purchase do not qualify as an exchange.  The taxpayer may enter into an agreement to exchange with either (a) the Seller of the replacement property, (b) the Buyer of the replacement property, or (c) a qualified exchange intermediary.  Since individuals are subject to liens, judgments, incapacity or vacations, the taxpayer is well advised to seek the assistance of professional exchange intermediary to facilitate the exchange.  Most professional intermediary companies will provide the exchange agreement and documentation, and will oversee the closing, reviewing closing instructions and settlement statements.

The taxpayer must identify the replacement property within 45 days of the date of closing on the relinquished property.  The taxpayer may identify up to three replacement properties without limitations on value.  The taxpayer may also identify any number of replacement properties  if their aggregate value does not exceed 200% of the aggregate value of all relinquished property.
A party to the exchange (i.e., the intermediary or the qualified escrow holder) must receive the written identification form, or "designation form," not later than the 45th day of the exchange.  There is absolutely no grace period. 

In addition to properly identifying the replacement property, and staying within the limited number of properties, the taxpayer must acquire the title to the replacement property the sooner of (1) his or her tax filing date, or (2) 180 calendar days from the date in which the relinquished property was transferred (tax filing extensions not with-standing).

The taxpayer cannot receive cash from the exchange, have the right to receive cash (including the interest or "growth factor"), or have control over the exchange funds, directly or indirectly, during the course of the exchange without creating a tax liability or disqualifying the exchange.  The actions taken during the course of the exchange must coincide with the taxpayer's intent.  The taxpayer is in construcive receipt of the exchange funds if they even indirectly "enjoy the benefit of" the funds.  These issues are more specifically addressed in the "safe harbors"  discussion in the current regulations. 

"Safe harbors" include a "qualified intermediary, " "qualified escrow accounts or trusts," or "qualified security or guarantee arrangements."  The taxpayer will not be considered to be in constructive receipt of cash or replacement property if the transaction utilizes these safe harbors. 

The qualified intermediary must acquire both the relinquished property and the replacement property.  This requirement can be satisfied by the intermediary acquiring title to the property or accepting an assignment of contractual rights, notifying all the parties prior to the transfer date, and causing the direct delivery of the property.

There have been a number of recent developments, which are of some interest to taxpayers.  Those involve exchanges of conservation easements, water rights, timber rights, and wetland mitigation credits.  For more information on Section 1031 Tax Deferred Exchanges, please visit the following links:

 www.irc1031x.com .  American Equity Exchange, the 1031 Authority.

1031 exchanges
Managing a 1031 exchange is not difficult - but it does require adherence to strict 1031 tax exchange rules and regulations.You must enter into a 1031 exchange with the advice of a tax professional.