1031 Exchange

Based upon the fact that each Section 1031 Exchange is different, we recommend that anyone considering a transaction of this kind should consult with an attorney, a tax advisor or a competent Qualified Intermediary to ascertain that the exchange is structured according to the Internal Revenue Code as well as the individual’s investment goals.

In usual real estate transactions, when a property owner sells a piece of his or her property, the individual is taxed on any profit resulting from the sale. When a sale is made through a Section 1031 Exchange, the tax on the profit is deferred until some future date.

The Section 1031 Exchange reasoning is that if the property owner reinvests proceeds of a sale into another property within a stated period of time, this profit has not occurred in a manner that generates funds to pay any tax. Consequently, the property owner’s investment is still the same but the form has changed. For example, an apartment building may be exchanged for vacant land and the only gain has been on paper.

This is considered a “like-kind exchange” and the tax is deferred but it is not tax-free. If and when the property which has replaced the taxpayer’s original piece of property is sold and is not part of another 1031 Exchange, the original profit, plus any further profit which has been realized since the purchase of the replacement property, is then liable for taxes.

Definitions for purpose of Section 1031 Exchange: “relinquished property” is the property (land, building, etc.) which is originally owned by taxpayer and is traded for “replacement property”, which is the land, building, etc. that the taxpayer receives in exchange for his or her original property.

There are several different types of exchanges covered under Section 1031, as follows:

Delayed Exchange, which is the most common type of exchange that occurs. This type of exchange is defined as one where there is a gap of time between the transfer of the relinquished property and the purchase of the replacement property. There are strict time limits that cover this type of exchange which are delineated in the Treasury Regulations.

Simultaneous Exchange, which occurs when the relinquished property and the replacement property are exchanged at the same time.

Reverse Exchange is defined as one where the replacement property is purchased before the transfer of the relinquished property.

Build-to-Suit Exchange is defined as one where the taxpayer is allowed to make improvements upon the replacement property or build on this property using the money obtained from the exchange.

In order for deferment of taxable gain, value, equity and debt on the replacement property must be equal to or greater than that in the relinquished property.

All Section 1031 Exchanges must be handed by a Qualified Intermediary (QI), who is an independent party as determined by Treasury Regulations. He or she receives the proceeds of the sale and holds this money until such time as it is needed to purchase the replacement property. At that time, the proceeds are delivered by the QI to the closing agent.