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1031 Exchange Requirements

Exchanges called 1031 exchanges are a power tax tool to avoid the burden of capital gains taxes. Capital gains taxes may be levied upon the sale of any capital asset that has experienced appreciation during the time period the tax payer has held it. By entering into a 1031 exchange upon the sale of the asset, capital gains taxes can be deferred indefinitely.

Section 1031 of the IRS code

Section 1031 of the IRS code lays out the basic eligibility requirements for a 1031 exchange. "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment," it states.



Basically, if the tax-payer is selling property that he has used for business purposes or held as an investment, he can defer his capital gains tax obligation by using the proceeds from the sale to purchase a similar property that will also be used for business purposes or held as an investment.

Like-Kind

The term "like-kind" in the tax code merely means that the taxpayer cannot use proceeds from the sale of an asset in a specific asset class to purchase a new asset in a different asset class. In short, real estate for real estate, livestock for livestock or rare gems for rare gems meet the definition.

QI

A 1031 exchange must be initiated concurrently with the close on the sale of the relinquished property. At that time the funds must be transferred to a qualified intermediary (QI), whose primary role is to hold the funds and assist in identification of potential replacement properties.

Timelines

From the date of closing you have 45 days to identify your potential replacement property or properties. Additionally, within 180 days of the close on your relinquished property you need to complete the purchase of your replacement property. These timelines are hard and fast; failure to abide by them will result in the taxpayer having to pay the tax.

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