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What Is A 1031 Tax Deferred Exchange?

What is a 1031 Exchange?

A "1031 Exchange" refers to section 1031 of the Internal Revenue Code. Section 1031 allows an investor, or business to defer recognition of a gain in property held for productive use in business or trade, or for investment, provided that asset is exchanged for like-kind property.

The 1031 Exchange is a critical component of the investment real estate business as it promotes and encourages continued investment in commercial real estate. More specifically, a 1031 Exchange allows investors and businesses to defer capital gains tax on their real estate assets if they use their entire equity in those assets to acquire other "like-kind" property through the 1031 exchange process.

The 1031 Exchange Process

The process is strict and technical and requires advice and guidance from an accountant, attorney, and real estate professional. The seller (exchanger) will have to identify a certain number of potential properties within the identification period and complete an exchange for one (or more) of those properties within the entire exchange period which is the shorter of 180 days, or the day their tax return is due.

1031 Exchange Qualified Intermediary

The seller (Exchanger) can also NOT receive any proceeds through the exchange process or it will be considered taxable. A Qualified Intermediary is used to facilitate the 1031 exchange process and ensure compliance with its requirements. The Qualified Intermediary will hold funds, be assigned interests of the Exchanger as seller and buyer, and prepares legal documents.

1031 Exchange Specialists

Because there are a whole host of financial, legal and tax issues involved, it is imperative to obtain the advice of 1031 Exchange Specialists. 1031 Exchange specialists include Certified Public Accountants, experienced real estate professionals, and Qualified Intermediaries for investors or businesses who may face a capital gain on the sale of an investment property or commercial property.

The 1031 Exchange rules are specific and unforgiving. Like kind exchange time limits are absolute. Equity requirements are mandatory. Many restrictions are placed on rolling gains into like kind property. For this reason, expert advice and guidance is mandatory to avoid pitfalls and costly mistakes.

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