1031 Exchanges: A Primer

A 1031 Exchange is a real estate transaction that permits real estate investors to sell investment property and use the funds to acquire a replacement property without having to pay capital gains tax at transfer. This type of exchange is method of deferring tax that is governed by Internal Revenue Code Section 1031, and is related rulings and regulations. There are several strict rules for compliance in order to qualify for a 1031 transaction, and it is crucial that you hire an experienced qualified intermediary and agent to assist you with this process. A real estate investor is unable to perform these tasks itself.

The subject real estate must be used in a trade or business or for business, and the replacement property must be “like kind.” First, the relinquished and replacement properties must be used in a trade or business, or for investment purposes. In other words, conducting valid business operations on the property or renting property to tenants is acceptable. Second, the relinquished and replacement property must be “like kind,” which is broadly interpreted to include properties as previously described.

Before entering into a purchase and sale agreement, it is recommend that you retain a professional 1031 exchange provider that will serve as a qualified intermediary. This organization will ask that you enter into an exchange agreement and will hold the proceeds of your relinquished property in escrow until the time you need to pay for the replacement property. These escrowed funds cannot be access by the Buyer / Seller, and can be used to pay the existing liens and closing costs of the relinquished property, and purchase price and closing costs for the replacement property.

After the closing for the relinquished property you will have forty-five (45) days to identify the replacement property that you will purchase. You may initially identify up to three (3) replacement properties. If you designate multiple properties, you can use your sale proceeds and tax deferred gains to purchase multiple replacement properties. Within one-hundred and eighty (180) days of the closing date for the relinquished property, or before the due date for the investor’s tax return. Here, it is important to note that if you close the relinquished property after October 17 and before December 31, you will have less than one hundred and eighty (180) days to close on your replacement property. Here, the timing of the sale of your outbound investment property, and purchase of replacement properties is absolutely crucial. In addition to retaining a professional qualified intermediary, it is important to line up replacement properties prior to the sale of the relinquished properties, and to watch the calendar when scheduling closing dates late in the year.

If you are a real estate investor, and require require assistance in your real estate transactions, please contact Northshore Legal at 781-463-6063.