1031 Exchange: The when, the why and the how

*NOTE – This article was originally written in July of 2006 for the newsletter. This article was actually provided by Greg Schowe of Asset Preservation, Inc. (www.apiexchange.com)

The burden of capital gains taxes can take a bite out of your profits, when it comes time to sell your investment property. When an investment property is sold, any unsheltered capital gains will be subject to significant taxation. One method you can employ to avoid this problem, is to utilize a §1031 tax deferred exchange. If used properly, this method is capable of indefinitely deferring the payment of capital gains taxes.

WHAT IS IRC SECTION 1031?
Section 1031 of the Internal Revenue Code allows an owner of investment property to exchange property and defer paying federal and state capital gain taxes (up to
15% Federal, 25% depreciation recapture and applicable state taxes) if they purchase a “like-kind” property following the rules and regulations of the Internal Revenue Code. This allows investors to use all of the sale proceeds to leverage into more valuable real estate, increase cash flow, diversify into other properties, reduce management or consolidate holdings.

WHAT IS “LIKE-KIND” PROPERTY?
There is some confusion regarding what type of property qualifies for a §1031 tax deferred exchange. The Internal Revenue Code Section 1031 states that “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.” “Like-kind” property can include, but is not limited to, any of the following, provided it is held for investment:

• Single Family Rental
• Duplex
• Apartment
• Commercial Property
• Raw Land

For example, raw land can be exchanged for a single family rental, or apartments or a commercial building. Properties can be exchanged anywhere within the United States.

DOES AN EXCHANGE NEED TO BE SIMULTANEOUS?
No, contrary to what some property owners envision, a §1031 tax deferred exchange is rarely a two-party swap. Most exchanges are delayed exchanges, whereby the Exchanger has 180 days between the sale of the relinquished property and the closing of the replacement property. They must identify the potential replacement property (or properties) within 45 calendar days from closing on the relinquished property.

WHEN IS A §1031 EXCHANGE APPLICABLE?
It is applicable whenever a property owner intends to sell any property that is not their primary residence (and falls under the definition of “like-kind”) and plans to buy another “like-kind” property within 180 calendar days following the closing of the relinquished property.

Paramount to any exchange is a competent and experienced Qualified Intermediary. Greg Schowe of Asset Preservation can provide this experienced guidance to ensure your transaction runs smoothly from beginning to end. Contact Greg at 314.369.8766 or greg@apiexchange.com for more on how you can make the §1031 exchange work for you.

Asset Preservation, Inc. does not give tax or legal advice. The information on this page should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor.