A 1031 Exchange (also called a Like Kind Exchange) is the exchange of certain types of property which may defer the recognition of capital gains or losses due upon sale, and therefore defer any capital gains taxes otherwise due. To qualify for a 1031 Exchange, the properties exchanged must be held for investment or for productive use in a trade or business. They must also be of 'like-kind.' Like-kind properties are of the same nature or character regardless of grade or quality, and generally refer to any property classified as real estate located in the United States.
The popularity of 1031 Exchanges has grown recently, especially in cases where people are ready to sell a property that they’ve held long-term which has a low tax basis and multiple years of depreciation deductions. If these owners sold their property outright, they could face significant federal and state income taxes. In order to avoid this scenario, they can participate in a properly structured 1031 Exchange.
What property qualifies for a 1031 Exchange?
- Both the property being exchanged and the new property being received must be held for investment or for use in a trade or business.
- The new property being received must be of like-kind to the property being exchanged. Like-kind property is property of the same nature, character or class; quality or grade is irrelevant. Most real estate will be like-kind to other real estate.
Timeframes for a 1031 Exchange
1031 Exchanges do not have to be simultaneous, but they must meet two time limit conditions that run concurrently or the entire gain will be deemed taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters.
According to the first condition, the owner of the property being relinquished has 45 days from the date they sell the property to identify potential replacement properties. The identification must be in writing, signed by the party completing the exchange, and delivered to a person involved in the exchange such as the seller of the replacement property or the qualified intermediary. Replacement properties must be clearly described in the written identification, such as a legal description, street address or distinguishable name.
According to the second condition, the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier.
Acquire Real Estate does not advise or provide any legal or tax advice and we recommend that you speak with your own accountant or attorney.