Also known as a tax deferred exchange, a 1031 exchange is an approved Internal Revenue Service (IRS) device which allows to sell business or investment property and to buy a replacement property without having the need to make capital gains tax payment on the real estate transactions.
Under normal circumstances, business organizations or investors that sell business or investment property will need to pay capital gains tax on their investment. But by tapping on this 1031 exchange regulation, businesses can delay the capital gains tax payment if the original investment or business property is exchanged (instead of sold) for a like-kind property.
For a 1031 exchange to be effective, the value of the replacement property has to be equal or more than the original property. In those cases whereby the replacement property has a lower value than the original property, the property value difference will be taxable.
Based on IRS regulations, the replacement property has to be identified within forty-five days of the closing on the original property. An investor or business is usually allowed to identify three or less replacement properties, but there are exceptions to this rule. However, no matter how many replacement properties are identified, the investor or business must acquire all replacement properties within one hundred and eighty days of the closing on the original investment or business property that the investor or business has relinquished.
One key information you need to know is that if the investor or business receives the proceeds of the sale of the original property directly, the 1031 exchange will not be valid in such a case. Therefore, in order to benefit from the 1031 exchange, you will need a qualified intermediary to hold and disperse the sale proceeds. A law firm can assist in preparing all the documentation necessary to facilitate the 1031 exchange.