1031 Tax Exchange

A 1031 exchange is an exchange of property in which capital gains tax deferral is available to real estate owners who sell their investment, rental, or business real estate, and reinvest the proceeds in qualified replacement properties. The replacement property must be similar in nature (to be used for investment, rental, or business) and therefore considered “like-kind”. Property owners may sell and replace like-kind properties and defer taxes on the profits by meeting the requirements of Internal Revenue Code (IRC) for 1031 exchange properties.

Sellers of 1031 exchange properties have a maximum of 180 calendar days from the closing of the initial sale of the relinquished property to complete the exchange into their replacement properties. Within the first 45 days of after close a seller must designate replacement properties and properly identify them in compliance with IRS regulations. This most frequently is done by using a Qualified Intermediary, also known as an Exchange Accommodator.

There are three rules for identifying replacement properties for a 1031 tax exchange.

• The most common is the three property rule which states that a seller may identify up to three replacement properties regardless of their value.
  
  
• The second rule is that a seller may identify any number of replacement properties but the combined value may not exceed 200 percent of the value of the initial property sale.
  
  
• The third rule for identifying replacement properties is any number of properties of any value may be identified as long as the final value of the properties exchanged into is equal to 95% of all of the replacement properties identified.

The funds in a trust account with the Qualified Intermediary can be used as deposit or earnest money in the purchase of the designated replacement property once all IRS requirements for a 1031 exchange are met. If no new properties are identified in the first 45 days and no designated transaction is completed during the full 180 day period, the funds in the trust account will be liquidated and the sale proceeds taxed at the prevailing state and federal capital gains and depreciation recapture taxes.

Many investors don't take advantage of 1031 exchanges because of the fear of the 45 day identification period. This fear is supported by numerous horror stories of failed exchanges and the resulting devastating taxes that can result from such failures. With proper planning and the right resources investors can navigate the waters of a 1031 exchange and frequently double or triple their investment income while diversifying their portfolio thus reducing risk. Key requirements are a good grasp of the exchange process, a clear set of investment objectives and a plentiful and consistent source of quality replacement properties.

National Commercial Property Loans can provide the financing for the difference in the exchanged property values. 

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