The Basics About 1031 Exchange

1031 Exchange refers to the section of the Internal Revenue Code Section that provides for the tax deferred exchange of real and personal property.

Simply stated, a 1031 exchange allows a person to "exchange" an investment property (be it business or a home) worth a certain number of dollars for another investment of "like kind". Since any profits have been reinvested into the new property, the taxes on those profits can be deferred until ultimately , the investor divests himself of the property. At that time, the grim reaper of reality shows up, and the deferred taxes along with any new taxes on the transaction become due at once.

Some general guidelines for a 1031 Exchange:

• The value of the replacement property must be equal to or greater than the value of the relinquished property less any selling expense.
• The equity in the replacement property must be equal to or greater than the equity in the relinquished property.
• The debt on the replacement property must be equal to or greater than the debt on the relinquished property.
• All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.
• Constructive receipt of sales proceeds is prohibited during the exchange process.
• Deadlines for identifying and closing on the replacement property must be followed.

If a few or our grandparents/great-grandparents had known about the 1031 exchange, maybe the great depression could have been the so-so depression. It's a little known fact that this suddenly popular side route that allows an investor (and that can be a private individual as well as a broker) to indefinitely delay the payment of taxes when properties are exchanged without a profit, has been legal since 1921. Unfortunately, it took the housing boom to bring it to that attention of the Real Estate savvy, and the housing slump to open the rest of our eyes to what it can do.

However, it is important to realize that a 1031 exchange is not a ride on the tax-free gravy train. Eventually the investment is sold, hopefully at a profit. Then, the taxes on the first and last sale will have to be paid.