1031 Exchange | Defer Capital Gains Tax | EquityRoots c

What is a 1031 Exchange?

The term ‘1031 Exchange’ comes from Section 1031 of the Internal Revenue Code. It states that “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 like kind which is to be held either for productive use in a trade or business or for investment.” Simply put, 1031 Exchange is a powerful tax deferral strategy! It offers a property owner the opportunity to defer all federal and state capital gain tax liability, money that would otherwise be paid in taxes, and reinvest that into more valuable property [2015 Tax Rates: Federal, Long Term Capital Gain Tax Rate 15% + Depreciation Recapture 25% + Applicable State Taxes]. It facilitates as a mechanism to grow your portfolio, leverage buying power and increase return on investment!

How does a 1031 Exchange work?

The IRS has set out a number of requirements that must be met in order to qualify for tax deferral under Section 1031. Both the relinquished property and the replacement property must be qualified property of like-kind, time requirements must be strictly followed, and an actual exchange must take place.


Qualified Property of Like-Kind

To classify as qualified, property must be held for either investment or for productive use in a trade or business and exchanged for property of like-kind. This does not necessarily mean the same, exact type of property. Instead, it relates to the nature, character or class of properties. For income tax purposes, real estate is divided into four classifications which is made as of the date the transaction is made: (1) Held for business use, (2) Held for investment, (3) Held for personal use, (4) Held primarily for sale. The first and second classifications qualify for 1031 treatment and the third and fourth do not.

Time Requirements

The IRS imposes two time limitation periods on deferred exchanges and both must be met in order to qualify under Section 1031. An investor must close on the purchase of replacement property or identify potential replacement property within 45 days from closing on the sale of a relinquished property. More than one potential property may be identified for replacement however they must meet either the 3-Property Rule, 200% Rule, or 95% Rule. Exchangers then must close on replacement property 180 days after closing on the relinquished property or the due date for filing their tax return, whatever is earliest.


1031 Exchange Process. Owner of a relinquished property receives a replacement property as outcome of process.


Real estate used in a trade or business qualifies for 1031 treatment when exchanged for other business or investment real estate. There are two types of real estate used in a trade or business (1) Owner occupied and property is used in the owner's trade or business, (2) Rental income property and act of renting the property qualifies it as a property used in trade or business.

1031 Exchange Timeline. 1031 Exchange process takes 180 days to close on one replacement property.

In order to defer all capital gain taxes, replacement property must be of equal or greater value to relinquished property. It can take the form of another whole replacement property or a fractionalized property such as a tenant in common form of ownership or an interest in a Delaware Statutory Trust. And any funds not reinvested will be considered ‘boot’ and taxable.

Exchange of Property

As the name implies, to have a valid exchange, the property must be exchanged for other property and purchased through a specific process. This requires knowledge of the different ways a 1031 Exchange can be structured and the advantages, disadvantages, and finer points of each variation. Variations may take the form of a simultaneous swap, deferred exchange, reverse exchange, improvement exchange, or a combination. An important aspect of each variation is that the taxpayer must avoid actual and constructive receipt of proceeds during the exchange process.

Qualified Intermediary is Important- Let EquityRoots Help!

As previously mentioned, your replacement property may take the form of another whole property or a fractionalized property such as a tenant-in-common form of ownership or an interest in a Delaware Statutory Trust. This can be especially appealing for investors who desire full tax deferral and who have additional monies from the relinquished property not yet invested into suitable replacement property.

Dependent upon the specifics of each project, you may have the opportunity to invest and obtain an interest in a Delaware Statutory Trust which the IRS has ruled that for tax purposes, it is to be treated as a direct interest in real estate under Section 1031. However, if you choose not to invest in a Delaware Statutory Trust through our platform, it is imperative that you exercise due diligence.

As to qualify for tax deferral, an Exchanger cannot have access or control over the funds or other property while the exchange in is process. Unless an Exchanger is merely swapping properties in a simultaneous exchange, the IRS has provided that a Qualified Intermediary must be used as a go-between for the sale proceeds in order to avoid this problem. And even when performing a simultaneous swap, use of a Qualified Intermediary is suggested. This is a person or entity who acts to facilitate the exchange. While the Qualified Intermediary profession is currently unregulated, nationally, the IRS disqualifies agents of the taxpayer. So the careful selection of your Qualified Intermediary is essential to ensure a streamlined process and the security of your equity! Contact us today and we can recommend a trusted Qualified Intermediary for your specific situation.


Partnership Interest

Same TaxPayer Requirement

Delaware Statutory Trust

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