Information On 1031 Exchange Rules & Regulations

Under Section 1031, taxpayers can sell certain types of property and use the resulting profit to buy a similar property shortly thereafter. Taxpayers do not earn any profit from this transaction, which allows them not to pay capital gains taxes on the property in question. This, in turn, allows them to save money. And, since there are no limits on how often one can make 1031 exchanges, they may be able to save quite a fortune on the long run.

How 1031 Exchanges Work

When conducting 1031 exchanges, taxpayers can't buy just any property. It has to be "like-kind" - similar in nature to the property the taxpayers are selling. To put it another way, like-kind property must be a property of the same type (for example, real estate) and have similar value. If a taxpayer sells a building, a building he gets in return must be either just as valuable or more valuable. If the building is less valuable, the difference would count as a gain, and the taxpayer would be taxed accordingly.

To ensure that all processes are legitimate and fair to both parties, the taxpayers must conduct all their financial transactions through a qualified intermediary. That intermediary must be a neutral party that wasn't previously involved by either taxpayer. The intermediary handles the money and the paperwork and fills out the relevant tax forms. He or she holds onto the money until both parts of the exchange are completed.

Properties That Cannot Be Exchanged

There are several types of properties that cannot be exchanged under Section 1031. They include:

  • Residential Property - property that serves as the taxpayer's personal residence on both full-time and part-time bases. This includes their main homes, summer cottages and other temporary residence he or she owns. The restriction is good for one year.
  • Flipped Houses - houses that have been bought so that they can be refurbished and sold for a larger price as soon as possible.
  • Foreign properties - a taxpayer can't exchange his or her property for any property that is not located on United States territory.
  • Stock Market Investments - this includes stocks, bonds and bank notes
  • Certificates of Trust and Interests - this includes interests in a partnership and beneficiary interests

1031 Exchange Timeline

A 1031 Exchange must be conducted in two stages, and each stage cannot exceed a designated time limit. The limits cannot be extended under any circumstances. The two stages of the 1031 exchange can be described as follows:

  • Identification Period - during this period, a taxpayer must find a property that is like-kind to the property he or she is trying to sell. That doesn't have to be one property. So long as they fit the like-kind criteria, a taxpayer can select as many as he or she sees fit. The process must be completed within 45 days.
  • Exchange Period - during this period, a taxpayer must sell his or her property and buy a like-kind property. A taxpayer must finish every part of the process before 180 days, later or before the due date of that year's tax return (whichever comes first).
blog comments powered by Disqus