TAX DEFERRED (1031) EXCHANGES
A GENERAL SUMMARY FOR INFORMATION PURPOSES ONLY
The so-called “ten-thirty-one exchange” (1031 refers to the controlling section of the IRS Code) was designed and is administered for the purpose of delaying the payment of any taxes on capital gains as long as the principal(s) involved observe certain rules and time-lines.
No principal should engage in a 1031 exchange without seeking and receiving tax and other advice from a licensed professional tax expert. The following data are a broad outline of the mechanics of a 1031 exchange.
The properties to be exchanged must have been held for investment (the seller) and be held in future for investment (the buyer). A principal residence does not qualify for such an exchange.
When an owner (seller) wishes to “move up” and sells one income property with the intent to buy other income property, the following rules apply to the buying side of the move up:
– Within 45 calendar days of the close of escrow on the sold property, the seller-turned- buyer must identify in writing ( normally with an escrow holder) the property to be purchased; three may be identified and the second or third substituted should the first choice fail.
– The now-buyer must close the purchase escrow within 180 calendar days of the closing date of the sold property.
– The property bought must be acquired for a purchase price greater than the property that was sold by the seller-turned-buyer and must also have an encumbrance (mortgage) greater than that which was discharged at the sale of the now-buyer’s former property.
– None of the proceeds from the sale may pass to the seller-turned-buyer but must be placed with a third party “accommodator” for the duration of the escrow for the newly purchased property. As the time for close of the purchase escrow approaches, the accommodator will transfer the funds to the then-escrow holder.
There are a variety of other rules, of course, and it is for this reason that professional tax advice must be sought by the principal.
The exchange must be for a “like kind” investment: a single family dwelling that has been held for investment may be exchanged for multiple units, commercial/retail property, even raw land.
The buyer of the property sold by the seller-turned-buyer does not need to be bought by another party engaged in a 1031 exchange; equally, the property purchased need not be sold by an individual wishing to make such an exchange.
The term “tax deferred” means just that. Either at death (as part of an estate) or when the principal sells the “last” investment property owned, there must be a reconciliation and payment of taxes on the capital gain, starting with the principal’s first unit and finishing with the last.
Always talk to your CPA about any tax questions or liabilities.