1031 Exchange refers to the section of the Internal Revenue Code Section that provides for the tax deferred exchange of real and personal property.
Why Do a 1031 Exchange?
With a 1031 Exchange investors can trade up, consolidate, diversify, leverage or relocate their investments and not be penalized by having to pay either capital gains or recapture (the amount deducted while owning the property is taxable if the property is sold). The taxes are deferred until the investor does a non 1031 Exchange sale or the property goes to the investors estate. When the property passes into an estate there is a step-up in basis to the then current market value.
1031 Exchanges can be both a powerful wealth building tool and a way of adjusting investment portfolios to more accurately reflect life style choices and circumstances. An example would be an apartment owner wanting to trade into NNN properties or Tenant in Common properties that require little to no management.
Other investment objectives are to adjust the amount of risk and volatility of one type of property to another, increase cash flow or to take the maximum amount of cash out of a real estate asset without triggering any taxes.
What are the general guidelines for a 1031 Exchange?
The value of the 1031 Exchange replacement property must be equal to or greater than the value of the relinquished property less any selling expense.
The equity in the 1031 Exchange replacement property must be equal to or greater than the equity in the relinquished property.
All of the net proceeds from the sale of the 1031 Exchange relinquished property must be used to acquire the 1031 replacement property.
Constructive receipt of sales proceeds is prohibited during the 1031 Exchange process.
Deadlines for identifying and closing on the 1031 replacement property must be followed.
Pursuant to IRC §1031, capital gain tax deferment requires the exchange of like-kind relinquished property for other like-kind replacement property. Contrary to the commonly held misconception that exchanged properties must be of the exact same type - for example, that bare land be exchanged for bare land or an income property be exchanged for another income property - the actual definition of like-kind is far more empowering in its flexibility. Any real property held for investment or real property used in a trade or business can be exchanged for any other real property held for investment or real property used in a trade or business.
For more information on 1031 Exchanges please call us at 415-453-3400 or email.