by Jennifer Minge

There are only two certainties in life: death and taxes. Taxes are the real curse of real estate investors since they reduce the potential gain on the sale of a property. If an investor uses a 1031 Tax Deferred Exchange when selling their property in order to purchase another investment property, they can avoid paying taxes on the sale immediately!

A 1031 Exchange receives its name from the IRS code the details the requirements of the exchange. Section 1031 of the IRS code 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.” A 1031 Exchange allows an investor to trade one or more investment properties for one or more “like kind” properties and defer the payment of income taxes. The IRS has ruled that all real estate is “like kind” meaning you can sell a house for a plot of land or sell or sell a duplex and buy a commercial shopping center.

Investors have to be very careful when following the IRS guidelines or they may find their exchange disallowed requiring them to immediately pay tax on the sale. The guidelines can be summarized into 3 requirements:
1) The investor cannot receive any material benefit from the sale of the property
2) The investor must identify potential replacement properties in writing
3) The sale and purchase of the new property must be completed in a limited timeframe with NO extension.

Material Benefit

The quickest way to have a 1031 exchange disqualified is for the investor to receive cash or other benefit from the sale before the exchange is complete. To avoid this scenario the investor can utilize a qualified intermediary who will control all monies until the exchange is finalized.

A qualified intermediary is an independent company that specializes in handling 1031 exchanges. The investor, their attorney, a CPA, or family members cannot serve as a qualified intermediary since the IRS has labeled them as disqualified persons.

Identify Replacement Property

An investor is allowed 45 days from the sale of the property to identify potential replacement properties. This list of properties must be in writing, include complete legal description and be delivered to the qualified intermediary during the 45 day period.

The criteria for the replacement properties is either a maximum of three properties without any consideration of the combined market value or any number of properties as long as the combined market value of all the properties does not exceed 200% of the value of the property that is sold.

Limited Timeframe

The investor is allowed up to 180 days from the sale of their property to purchase the replacement property or properties. The IRS does not allow for any extension of this timeframe. If the investor fails to close on the new property within 180 days then the exchange is disallowed.

A 1031 Exchange allows investors to greatly multiply the value of their real estate holdings since every penny from the sale of a property can be leveraged in the purchase of another property.