What is a 1031 Real Estate Exchange?
A Section 1031 exchange is an exchange of like kind property. This type of exchange allows a person with a piece of real estate or personalty such as a car or a truck to exchange it for like kind property. The value of this swap is that the person in most cases does not have to recognize any gain on the exchange. For example if Swap Guy wants to exchange his property A with John Smith for property B he can do so without recognizing gain. However, the trade off is that Swap Guy keeps the basis he had in property A for his newly acquired property B. Suppose Swap Guy had a basis in the property of $200,000 and it is worth $800,000. Property B is worth $800,000. At the end of the day, Swap guy now has exchanged property A for B and has not recognized the $600,000 of appreciation on the exchange under Section 1031. However, Swap Guy now has property B with a basis of $200,000. So if Swap Guy later sells the property for 950,000, he would have a gain of $750,000. That gain represents the $600,000 of appreciation or gain from Property A and the susequent appreciation of $150,000.
Extra Tax Break: If Swap Guy never sells the property, his family gets a step up in basis to date of death and no one ever recognizes the deferred gain. The family or recipient of the property at death can then depreciate the property based on the date of death value.
Final Point: Be aware that there is something called a deferred like kind exchange. This exhange allows the Seller to sell his property to one third party, park the proceeds with an escrow agent called a qualified intermediary, and then later identify and purchase through the qualified intermediary the like kind property with another third party. These complicated transactions are sometimes referred to as "reverse Starker transactions" named after a court case bearing this name.
The above is only an overview and the devil is in the details in these type of transactions but can be well worth it if structured correctly and with tax counsel assistance.
A 1031 real estate exchange is a process by which real estate changes hands, but in a way that is not subject to capital gains taxes in the United States. The exchange is seen as a very profitable way to exchange real estate, yet avoid taxes and some real estate investors use it often. However, there are strict rules associated with a 1031 real estate exchange. There are certain transactions which are not covered by the rules of a 1031 real estate exchange. Those who are depending on the provision should contact a tax professional, perhaps even a tax attorney, before engaging in the exchange. One of the main rules is that private property held for personal use cannot be exchanged under this provision. However, there may be some other exemptions for private property covered under other portions of the US tax code. A 1031 real estate exchange applies only to properties that are held as investment opportunities, usually commercial endeavors. Also, the provision does not apply to cases whe
Internal Revenue Code Section 1031 states specifically: “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 a like kind which is to be held for productive use in a trade or business or for investment”.
Have you said any of the following to yourself? • I’d love to sell this rental property, but I can’t afford to pay the taxes. • My accountant tells me the taxes would kill me if I sold my rental property. • Why sell? The government will just get all the profit. • After I sold this rental property and paid the taxes, I wouldn’t have enough cash left to buy the new property I want. If you have, then you are a great candidate for a 1031 Exchange. So, what exactly is a 1031 Exchange? Named after Internal Revenue Code Section 1031, a 1031 Exchange allows you to defer taxes on the profit you make when you sell investment real estate. The IRS requires you to comply with a few requirements, however. First, the old property you are selling and the new property you are buying must be rental/investment property or bare land. If you meet this test, you can sell any type of property (an apartment building) and buy any other type of property (an office building). Second, from the date of closing on
