Navigating the Maze of 1031 Exchanges
Section 1031 is an IRS Code provision allowing an exception to capital gains taxes due upon the sale on certain kinds of property. The focus has been on real property exchanges, as the requirements for a personal property exchange are difficult to meet.
To qualify for like-kind status, real property need only be held for investment or for productive use in a trade or business. Therefore, an apartment building could be sold and exchanged for the purchase of a beach rental property. Or raw land could be exchanged for a commercial building. Personal residences and second homes do not qualify for like-kind status.
The typical transaction contemplated in Section 1031 of the Code is a sale of qualified property, and thereafter a purchase of replacement property. The basis in the exchange property is carried over to the replacement property. The Code does allow the replacement property to be purchased first, although the rules are a little more complicated. In the typical sale, a replacement property is chosen within 45 days of the sale, and then purchased within 180 days from the sale. So long as the properties qualify for like-kind status, then no gain will be recognized.
The seller cannot receive the sale proceeds or have access to the funds. A “qualified intermediary”, such as a title company, holds the funds until the replacement property is closed. The sales contract for the exchange property should allow the contract to be assigned to the qualified intermediary, and the closing date on the purchase agreement, in order to close within the 180-day deadline, should be firm. There are no extensions of deadlines allowed under the Code. There may be special rules in your particular transaction, so, as always, a professional attorney or accountant should be consulted before any contracts are signed.