A 1031 Exchange, otherwise known as a tax deferred exchange, is a simple strategy and method for selling one property, that's qualified, and then proceeding with an acquisition of another property (also qualified) within a specific time frame.  The logistics and process of selling a property and then buying another property are practically identical to any standardized selling and buying situation, but a "1031 Exchange" is unique because the entire transaction is treated as an exchange and not just as a simple sale.  It is this difference between "exchanging" which, in the end, allows the taxpayer(s) to qualify for a deferred gain treatment.  In simple terms, sales are taxable with the IRS and 1031 Exchanges are not.
   
  
Why 1031 Exchange?
 
Any Real Estate Property Owner or Real Estate Investor should consider an exchange when he/she expects to acquire a replacement "like kind" property soon after the sale of his/her existing investment property.  Anything otherwise would require the payment of a capital gains tax, which can exceed 20-30%, depending on the federal and state tax rates of your particular state.  To make it easy to understand, when purchasing a replacement property (without the benefit of a 1031 Exchange), your buying power is reduced by the capital gains tax, to the point where it is 70-80% of what you previously had when you owned the property.  The points below are the basics that apply to all 1031 Exchanges.  The two major rules to follow are:

• The total purchase price of the replacement "like kind" property must be equal to or greater than the total net sales price of the relinquished real estate property.
    

• All equity received from the sale of the relinquished real estate property must be used to acquire the replacement "like kind" property.
    

The extent that either of these rules are violated will determine the tax liability accrued to the person executing the exchange.  In any case where the replacement property purchase price is less than the net sales price of the relinquished real estate property, there will be a capital gains tax responsibility incurred.  Keep in mind, however, that partial exchanges do in fact qualify for a partial tax-deferral treatment.  This simply means that the difference between the purchase price of the replacement "like kind" property and the net sales price of the relinquished real estate property will be taxed.

 
The 1031 Exchange Rule
 
A property transaction can only qualify for a deferred tax exchange if it follows the 1031 Exchange Rules as defined in the US Tax Code and US Treasury regulations.

The foundation of 1031 Exchange rules is that the properties involved in the exchange must be "like kind" and both properties must be held for a productive purpose in business or trade, such as an investment.

The 1031 Exchange rule also has a guideline for the proceeds of the sale.  The proceeds from the sale must go through the hands of a "qualified intermediary" (QI) and not through your hands or the hands of your agents, or all the proceeds will become taxable.  The entire cash or monetary proceeds from the original sale must be reinvested towards acquiring the new "like kind" real estate property.  Any cash proceeds retained from the original sale are taxable.

The second fundamental rule is that the 1031 Exchange rule requires that the replacement property must be subject to an equal or greater level of debt than the property sold or as a result the buyer will be forced to pay the tax on the amount of decrease. If not he/she will have to put in additional cash to offset the low debt amount on the newly acquired property.

 
1031 Exchange Timelines
 
There are 2 timelines that anybody going for a 1031 property exchange or
(TIC) should abide by and know.

The Identification Period: This is the crucial period during which the party selling a property must identify other replacement properties that he proposes or wishes to buy. It is not uncommon to select more than one property. This period is scheduled as exactly 45 days from the day of selling the relinquished property. This 45 days timeline must be followed under any and all circumstances and is not extendable in any way, even if the 45th day falls on a Saturday, Sunday or legal US holiday.

The Exchange Period: This is the period within which a person who has sold the relinquished property must receive the replacement property. It is referred to as the Exchange Period under 1031 exchange (IRS) rule. This period ends at exactly 180 days after the date on which the person transfers the property relinquished or the due date for the person's tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever situation is earlier. Now according to the 1031 exchange (IRS) rule, the 180 day timeline has to be adhered to under all circumstances and is not extendable in any situation, even if the 180th day falls on a Saturday, Sunday or legal (US) holiday.

  
More Information
 
For more information about 1031 Tax Deferred Exchanges, please contact one of our 1031 Specialists by contacting our office, or completing our Information Request Form.