Without a doubt, one of the most commonly asked questions is "What exactly is a 1031 Exchange?" The 1031 Exchange, named after the IRS code allowing the exchange, can allow you to sell business or invest real estate and replace it with other business or investment real estate without creating a taxable event.

Many investors don't realize that the sale of investment property does not have the same exclusion enjoyed when you sell your principal residence. If you sell the property for more than you paid for it, you usually have a taxable gain. With a 1031 Exchange, you can defer the payment of the tax normally due on sale.

There are many benefits to performing an exchange instead of a sale and purchase of another property. A 1031 Exchange can be a great way to have more funds available for the new purchase. Since a 1031 Exchange defers any tax payment, that money will now be available for the new property.

A 1031 Exchange can also help you with cash flow by allowing you to sell investment properties that aren't giving you as much return as you'd like and use the non-taxed gain to purchase one that produces cash flow. You can even trade out large property for several smaller ones or several small properties for a single large one.

To qualify for a 1031 Exchange, you must trade real estate that you hold for business or investment purpose for other business or investment real estate. For example, land can be traded for an apartment or vice-versa. 1031 Exchange cannot be used in property that involved a personal residence.

Here are a few things to keep in mind if you are planning a 1031 Exchange:

1. Both the old and new property must be either land or rental property (including business property).

2. You have 45 days from the closing date of your first property to name three properties you may purchase in exchange.

3. From the date of closing of the first property, you have 180 days to close on any of the three properties you identified in the first 45 days.

4. The proceeds must go to a Qualified Intermediary, who in turn buys the next property from your list of three. If you take proceeds from the first sale, each dollar taken may be subject to capital gain tax. To avoid the tax, you must rollover the entire gain into the new property.

5. You are not required to exchange all of your cash from the sale of the first property into the purchase of the second. However, taking cash from the sale can create a taxable event for you.

This can get very confusing. We'd love the opportunity to show you how it may work for you.

For details on a 1031 Exchange continue reading this page. If you would like even more details, we recommend you contact Bayview Financial Exchange Services or First American Exchange as the qualified intermediary. Bayview Financial Exchange Services has been generous enough to provide us with more in-depth 1031 Exchange information on this website, and we appreciate their emphasis on education. Finally, if you would like to see the IRS's position on 1031Exchanges, click here.

WHAT IS A 1031 EXCHANGE?
Internal Revenue Code Section 1031 provides that no gain or loss will be recognized on the exchange of any type of business use or investment property for any other business use or investment property. 1031 Exchanges are not really exchanges in the context of two-party barter. Instead, they are typical sales and purchases that involve the same exact ingredients as any other sale or purchase, without the capital gains. The only real difference is the investor is increasing his selling and buying power by electing to avoid the drain of taxes under Section 1031 regulations. No other aspects of the transaction are affected.

WHO SHOULD CONSIDER A 1031 EXCHANGE?
Anyone who is thinking about selling a business use or investment property should consider affecting a 1031 Exchange. An Exchange offers the astute investor an opportunity to reinvest the federal capital gains that would normally be handed over to the IRS and put that money to work for himself. You work too hard to simply pay the tax without carefully considering this reinvestment option. Essentially, 1031 Exchanges should be thought of as an interest free loan from the IRS; one in which the principal may be increased through subsequent exchanges and may never require repayment, if you plan properly.

MISCONCEPTIONS ABOUT EXCHANGING
1. Many still believe that you must “Swap” properties. Although this was required in the original code, this is rarely done in present times. 1031 Exchanges now enable one to sell their property to someone totally unrelated to the person from whom they are purchasing their replacement.

2. Many believe only investors of large commercial properties can utilize the benefits of Section 1031. The great thing about 1031 Exchanges is that it applies to all investment properties, large and small. It will work the same way for a corporation selling a large shopping center as it would for an individual selling a single-family home used as a rental property in a vacation area.

3. Many believe you must acquire a property of "similar use or service." While 1031 exchanges are also known as "like-kind" exchanges, like-kind simply applies to real property held for business use or investment. Therefore, an investor may sell raw land and acquire a five-unit apartment building or sell a warehouse and acquire raw land. He can sell one property and acquire three or sell four and acquire one. Virtually any type of real property used for business use or investment will qualify.

4. Many believe 1031 exchanges are very complicated and not worth doing. The fact is that when working with a qualified intermediary who specializes in Section 1031 tax deferred exchanges (such as Bayview Financial Exchange Services), the exchange process is very simple. The intermediary will keep you aware of your time deadlines and ensure you do everything in strict compliance with IRS regulations.

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