The Internal Revenue Code Section 1031 provides that no gain or loss will be recognized on the exchange of any type of business use or investment property for any other business use or investment property. 1031 Exchanges are not really an exchange in the context of two-party barter. They are typical sales and purchases that involve the same exact characteristics as any other sale or purchase, without capital gains. The only real difference is the investor is increasing his selling and buying power by electing to defer the drain of taxes under Section 1031 regulations. No other aspects of the transaction are affected.
If you are considering selling a business use or investment property you should consider effecting a 1031 Exchange. This offers the educated investor an opportunity to reinvest the federal capital gains that would normally be handed over to the Internal Revenue Service.
There are many that think that properties must be "swapped". In the original code this was a requirement, but is rarely done presently. Now a 1031 Exchange will enable one to sell a property to another party totally unrelated to the party from whom they are purchasing the replacement.
Another misconception is that only investors in larger commercial properties are eligible for the benefits of Section 1031. 1031 Exchanges apply to all investment properties, large or small. A Corporation selling a large industrial park can benefit the same as an individual selling a home used as a rental property in a vacation area.
Some think that you must acquire property of "similar use or service". The term "like-kind" exchange is often used when describing 1031 exchanges. This applies to real property held for use as business or investment. As an example, raw land may be sold with a replacement property being an industrial park or rental apartment building. One property may be sold and three purchased as replacement. Basically, any real property used for business or investment will qualify.
1031 exchanges are not as difficult as one may be lead to believe. If working with a qualified intermediary that specializes in Section 1031 tax deferred exchanges, the transaction will be very smooth. A qualified intermediary will keep you appraised of your time deadlines and ensure that all steps are done in compliance with the Internal Revenue Service regulations.
A 1031 deferred exchange is an exchange in which you sell your qualified property called the "Relinquished Property" and subsequently purchase qualified property called the "Replacement Property".
For income tax purposes, real estate is divided into four (4) classifications. The Classifications are:
The first time limitation requires a Replacement Property to be identified within 45 calendar days of the transfer of the Relinquished Property. This is called the "Indentification Period".
The second time limitation is called the "Exchange Period". The exchange period begins on the date you transfer the relinquished property and ends 180 calendar days thereafter. The exchange must be completed during the "exchange period".
There are limitations on how many replacement properties you may identify in the same deferred exchange, no matter how many relinquished properties you sell.
You actually acquire the replacement property, close the transaction prior to the end of the exchange period and the replacement property acquired is the same as identified during the 45 day identification period.
The secret to a successful deferred exchange is to avoid receipt of money during the transaction.