What is a 1031 Exchange?
Section 1031 of the internal revenue code provides an alternative strategy for deferring the capital gains tax that may arise from the sale of a business or investment property. By exchanging real property for like-kind real estate, real property owners may defer federal tax obligations and apply all the proceeds toward the purchase of replacement property.
What are examples of like-kind real estate that qualify for 1031 exchanges today?
Wholly Owned Assets
Commercial Rental Property
Residential Rental Property
Doctors Own Office
Fractionally Owned Assets
Beneficial Interest in a Delaware Statutory Trust (DST)
Tenant in Common Interest in Investment Property
Both the relinquished and the replacement properties must have been held for investment purposes or for productive use in a business. A primary residence does not qualify for a 1031 exchange property.
Potential Benefits of a 1031 Exchange
No gain or loss should be recognized on the exchange of real property held for business or investment when exchanged solely for like-kind property held for productive use in a business or investment property.
For example a person may elect to sell a residential rental for $1,000,000 as a relinquished property and diversify by investing in three replacement DST properties, one third in Student Housing, one third in Assisted Living, and one third in Climate Controlled Storage.
Potential for Increased Income
It may be beneficial to exchange properties with diminishing income for other property offering greater income potential.
Improved Purchasing Power
Rather than paying the tax on the relinquished property, use that money to purchase a replacement property of higher value.
Reprieve Management Responsibilities
Often people become tired of the responsibility of property management and maintenance, and at this time they choose to exchange into properties which are fully managed for them.
The 1031 exchange process has three essential steps.
The exchanger (investor) sells a property known as the relinquished property, and most importantly at the close that sale, the proceeds are escrowed with a “QI,” qualified intermediary. The exchanger (investor) does not touch the proceeds.
The “QI” qualified intermediary, through a written agreement with the exchanger (investor), holds the proceeds in the escrow account, and then transfers those funds to the close of the replacement property purchase.
The exchanger (investor) receives ownership of the new replacement property or ownership of an interest in a Delaware Statutory Trust (DST).
Close on the sale of the relinquished property.
Last day to identify potential replacement properties.
Last day to close on replacement property purchase.