1031 Tax Deferred Exchange Summary

Section 1031 of the United States IRC allows an owner to sell appreciated assets (usually, but not always, real estate investments) and defer the payment of capital gain taxes by acquiring one or more replacement assets. 1031 Exchanges allow the investor to keep their equity invested (and hopefully growing) in the present instead of paying the capital gain tax amount to the government.

1031 Exchange Requirements

Qualified Use / “Like-Kind”: Section 1031 requires that the asset sold and assets purchased must be similar in use. Generally, real estate assets held for investment qualify as being appropriately similar.

Accommodator: Both the sale of the existing asset and purchase of the new asset have strict structural and legal requirements. A “Qualified Intermediary” (or “1031 Exchange Accommodator”), usually a title or escrow company, must be utilized. They will complete the necessary documentation and ensure legal and regulatory compliance. The Accommodator also must be assigned into the Purchase and Sale Agreement and Escrow Instructions for both the sale and purchase. Funds from the sale will be held in an escrow account with the Accommodator in anticipation of closing the exchange purchase.

Replacement Values: In order to avoid paying any tax, all funds raised from the asset sale must be reinvested in new asset(s) that are equal to or greater in value than the asset sold. Additional cash may be added to purchase assets with higher values. Additionally, if the asset sold utilized debt financing, the replacement asset must have equal or greater debt financing.

1031 Exchange Deadlines

Identification: The exchanging party has 45 days from the date of closing of the sold asset to identify potential like-kind replacement assets to the Accommodator. The exchanging party can identify a) three (3) assets of unlimited value or, if there is a desire to identify a larger number of properties, either b) an unlimited number of assets with a maximum fair market value equal to 200% of the asset sold or c) an unlimited number of assets so long as 95% of the fair market value of identified assets are actually purchased.

Closing: The purchase of the replacement asset(s) must close within 180 days of the sale of the relinquished asset.

1031 Exchange Structures

Forward (or Delayed): The most common 1031 exchange whereby an asset is sold and a replacement asset is later purchased within the above deadlines.

Reverse: It is possible to purchase the replacement asset(s) prior to the relinquished asset being sold, however capital must be available to make the purchase without the use of funds from the asset sold.

Tenants-in Common (“TIC”): This is an important legal structure allowing multiple parties to purchase a direct interest in an asset. Under 1031 Exchange rules, the same entity selling an asset must purchase the replacement asset, meaning the seller of the relinquished asset may not enter a new partnership for the purchase of the replacement.

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