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A Brief Explanation of
1031 Exchanges


Defined:
A 1031 tax deferred property exchange is an exchange in which capital gains tax deferral is available to real estate owners who sell their investment, rental, business or vacation real estate, and reinvest the net proceeds in other qualified real estate.  Real estate purchased for these purposes is called like kind or 1031 real estate.

Purpose:
The purpose of the 1031 exchange rules is to allow sellers to buy replacement property of like kind within the statutory time frame established by the IRS.  The exchange defers the capital gains taxes normally due on the sale of investment property until the replacement property is in turn exchanged or sold.

Process:
(see also the summary below)
  • Sellers must conduct all sales and exchange transactions (at arm's length) through a designated qualified intermediary (QI) (see links page for some companies that can perform this service) who will hold title and place monies from your sale in a trust account for the purchase of the new property(ies).  Please note that if at any time, you have any control over any of the funds that result from the sale of your qualifying property, you will be required to pay the capital gains taxes due on those funds.
  • The time periods for conducting a 1031 exchange start on the day you close on the sale of your qualifying property.

    • Within the first 45 days of this period, you must designate candidate properties and properly identify them to the IRS (usually through your Qualified Intermediary)
    • Then you will have a maximum of 180 calendar days to complete the exchange.

  • You may identify up to three properties regardless of value or a group of properties with a combined value that does not exceed 200 percent of the value of the initial property sale.
  • If no new properties are identified in the first 45 days, or, if no designated property is closed during the full 180 day period, the trust will be liquidated and the sale proceeds will be taxed at the prevailing capital gains rate

The IRS Rules for Exchanges..
You will need to follow 4 general rules, and 2 timeline rules
for your exchange to meet stringent IRS regulations:


Real Property Use.
Both your old and new properties must qualify as investment or business use. If both properties pass this test, you can exchange nearly any type of real estate.
Reinvestment Requirement.
To defer all of your capital gain tax, you must buy a property equal or higher in value than the one you sold. A lesser reinvestment amount may result in some residual tax liability.
Qualified Intermediary (QI).
The IRS mandates that you use a QI to prepare the legal documents for your exchange. Because the QI must be independent, it cannot be your friend, employee, broker, or even your accountant or attorney. The QI also holds your money, so that you do not have access to it
Proper title holding.
You must purchase and take title to your new property exactly as you held title to your old property.


Time Line For Exchange
45 Day Identification Period. You have 45 days from the closing of your sale to list the properties you may want to buy. There are no exceptions to the deadline.
180 Day Exchange Period. From the sale closing date, you have 180 days to close on the purchase of one or more properties from the 45-day list. Again, there are no exceptions to this deadline.

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