Fundamentals of the 1031 Exchange Explained

1031 Exchange Basics

When a real estate investment is sold it is generally a taxable event. The proceeds of that event must be reported as income in the year the sale happens. However, there are a few cases where this general rule does not apply. The purpose of this article will be to explain one of these exceptions: the 1031 exchange.

The 1031 Exchange Outlined

Under federal tax law when real estate is exchanged under a particular set of circumstances, taxes may be deferred. This tax deferral is allowed when the proceeds from the sale of real estate is used to purchase a like kind property as understood by federal tax law. In short, you put up for sale an investment property, give the funds from that sale to a qualified intermediary, then reinvest the funds into another real estate investment. Should this be performed the right way, with the right professional assistance, taxes are deferred as long as the capital remains invested.

When considering selling your property you have several options

1. Sell your property and pay the capital gains.
2. Sell your property, pay the capital gains, and then use whatever is left to invest in your next real estate purchase.
3. Last, you can sell the real estate investment, work with a qualified intermediary, purchase a like kind property, and pay no capital gains.

Now, obviously we would all pick the third option if we understood the steps involved. It is highly recommended that each investor discusses their specific situation and needs with an experianced professional. It is fairly simple but you do need to follow the rules carefully or you may be subject to capital gains taxes. Follow the rules and you will be able to continue to realize the benefits of your investment without paying capital gains when you move your investment. This is of course very beneficial for people who have had real estate appreciate considerably and would like to invest in other types of property.

Before you do 1031 exchanges you need to grasp the following:

1. Like Kind Property
2. The Qualified Intermediary
3. Tenancies in Common

We reviewed the specifics and more. Of course you will need to consult a professional in order to ensure you really are able to meet the terms of Section 1031 of the federal tax code.