What is a 1031 Exchange?
Section 1031 of the United States Internal Revenue Code (26 U.S.C. § 1031) offers taxpayers the ability to defer capital gains taxes on the sale of real property that is held for business or investment purposes.
This is done via an exchange process that involves investing the sale proceeds in a new property of the same type (like kind) – A 1031 Exchange.
In the context of IRC Section 1031, “like kind” generally means any property that is classified as real estate in any of the 50 U.S. states or Washington, D.C. and in some cases, the U.S. Virgin Islands. This means that taxpayers who sell one commercial or residential property with the intent to reinvest the proceeds in a similar property may not have to pay income taxes on any gains realized from the sale.
No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment, if such real property is exchanged solely for real property of like-kind which is to be held either for productive use in a trade or business or for investment.IRC Section 1031(a)(1)
1031 Exchange Techniques
A properly structured 1031 Exchange, or Tax-Deferred Exchange, is one of the most powerful tax deferral strategies available to taxpayers. There is more than one way to structure a tax-deferred exchange under Section 1031 of the Internal Revenue Code, but there is one element almost all have in common: the use of qualified intermediaries to facilitate the delayed exchange between a taxpayer, a buyer, and a third party seller.
1031 Safe Harbors
IRC Section 1.1031(k)-1(g) describes four safe harbors that can be used to establish that a taxpayer is not in actual or constructive receipt of money or other property for purposes of Section 1031.
- Security or Guaranty Arrangements
- Qualified Escrow and Qualified Trust Accounts
- Use of Qualified Intermediaries
- Interest and Growth Factors
More than one safe harbor can be used in the same deferred exchange, but the terms and conditions of each must be separately satisfied. The Qualified Intermediary Safe Harbor (IRC Section 1.1031(k)-1(g)(4) is the most important safe harbor and constitutes the most significant portion of the 1991 treasury regulations.
A qualified intermediary (QI) is a person other than the taxpayer or any disqualified person (such as family member, agent, accountant etc.). The taxpayer transfers certain rights in the sale contract to the QI who, for tax purposes acquires the old property and transfers it to the new owner. When the new property is selected, for tax purposes the QI acquires the new property then transfers it to the taxpayer.
The attorney team and title specialists at The Closing Agent can help you structure your 1031 exchange so that it is in full compliance with the safe harbor regulations including making available the services of a qualified intermediary and providing for the establishment of qualified escrow or qualified trust accounts.