What is a 1031 Exchange?

A 1031 Exchange is a method by which a property owner exchanges one or more relinquished properties for one or more replacement properties of “like-kind“, while deferring the payment of federal income taxes and possibly some state taxes on the transaction. This tax deferred strategy accomplishes 100% deferral of capital gains indefinitely.

There are several variations of a 1031 exchange, but the most common and practical application is what is known as a 1031 Starker exchange. The 1031 exchange allows for a property owner to exchange their property for another property and defer capital gains taxes on the transaction. By allowing for the deferral of capital gains taxes, you are able to preserve the value of your real estate which enables you to secure more lucrative properties. This process of trading up and preservation are part of the wealth building cycle for real estate investors and wealth builders

Benefits of using a 1031

  • Allows for a full and indefinite deferral of capital gains
  • Enables trading up to more desirable properties or assets
  • Enables the ability to generate new depreciation when old property has reached the end of the depreciable life

    • Issues and Challenges with a 1031 Exchange

  • Does not provide a exit strategy from real estate
  • Keeps money illiquid for retirement planning or business development
  • Can be difficult to find suitable property in 45 days
  • Additional monies or other assets (i.e. “boot”) may be required to complete the transaction

    • How Does a 1031 Exchange Works
    The 1031 exchange consists of two (2) phases:
    1) Sell Current Asset
    2) Find Replacement Property

    The steps required for each phase are described as follows:
    Phase I - Sell Current Asset

    Phase 2 - Find Replacement Property
    Find a new property (45 days)
    QI Transfers funds to escrow
    Buy new property (Total 180 days to close)

    Importance of the Qualified Intermediary (QI)
    In order to meet the requirements of IRS code section 1031 it is required that an independent, unrelated, third party take possession of your funds. This is required in order to prevent what is known as constructive receipt of the funds. If you were to take possession of the monies at anytime in any form, your deferral of capital gains would be disallowed and taxes would be due in the year of disposition of the property. The Qualified Intermediary (QI) selected must be a trusted and responsible party or entity. The QI will be holding your monies for up to 180 days and they must be relied upon to return those monies when you instruct them.

    Who Do You Use as Your QI?
    Find a third party that has helped thousands of clients with their estate plans and real estate transactions, an entity who specializes in taxes, capital gains deferral strategies, 401(k) programs, etc. These will make them well qualified to assist you in understanding and navigating the issues associated with your 1031 exchange. They should be a registered and licensed Trust Co. and IRA custodian. As such they are a licensed and bonded entity. The holding of your monies in Trust insures that your monies will be handled and managed by a Trusted and regulated entity. This provides you with the peace of mind you need while completing your 1031 exchange transaction.

    If you have further questions please do not hesitate to contact Alpine Lakes Real Estate for assistance.