1031 Exchange

1031 Exchange Definition

A 1031 exchange refers to Internal Revenue Code (IRC) 1031 that allows the deferral of capital gains tax for the qualifying sale and repurchase of like-kind real estate.

Overview

For a 1031 Exchange, all properties must be considered investment properties for tax purposes, which means that an owner’s residence won’t qualify. “Like-kind” does not require that for investors to defer the capital gains from the sale of a property by repurchasing another property (replacement property), both properties must be similar to each other by its type. “Like kind” only means that both properties simply need to be held as an investment. Selling an apartment building and then purchasing an office building would usually qualify for a 1031 exchange, assuming the other conditions are met.

One of the most important elements of deferring all gains through a 1031 exchange is that the replacement property costs at least as much as the original property. Buying costs can be factored into the total price of the replacement property. While not meeting this condition will prevent investors from deferring all of their gains from the sale of the first property, they are still completely free to do a partial 1031 exchange if the replacement property is purchased at a lower sale price than the original property. In this case the extra amount of cash that the investor keeps from the sale of his property and that stays not reinvested (boot) is taxable.

Also, the IRS requires that the replacement property be identified within 45 days from the sale of the first property, and acquired within 180 days. Investors who continue to defer paying taxes on gains by rolling them into a like-kind property can repeat this cycle ad-nauseum and continue to acquire more real estate value. While a 1031 Exchange shields an investor from immediately paying taxes on the gains from the sale of a property, they must still file IRC form 8824 to establish that the taxes were deferred for the exchange of like-kind properties.