A 1031 tax deferred exchange is a method by which a taxpayer (“Exchanger”) who owns property which has been held for investment or in connection with a trade or business can exchange the property for like kind property which will be held for investment or in connection with a trade or business and defer paying taxes on some or all of the capital gains. The regulations which govern exchange transactions are in Section 1031 of the Internal Revenue Code.
The 1031 Exchange is normally administered by an independent exchange agent such as these listed below.
The Exchanger must “identify and designate” the replacement property(ies) on or before 45 days from the closing date of the sale of the relinquished property. The list of identified properties must be specific, it must show the property address, the legal description, or other means of specific identification.
The “identified and designated” replacement property must be acquired (by the Exchanger) by the earlier of:-
180 days from the closing date of the first relinquished property
The due date of filing the Exchanger’s federal income tax return, together with all extensions for the year the first relinquished property was transferred
Section 1031 requires that the taxpayer on the relinquished property be the same taxpayer on the replacement property.
Equal or Up Investment
Section 1031 stipulates that in order to defer 100% of the taxes on your gain on the sale of the old property, you must buy equal or up. There are two aspects of the equal or up rule. First, you must reinvest all of the cash that is generated from the sale of the relinquished property. Second, you have to buy a property (or properties) that has a sale price equal to or greater than the net sale price of the property you sold. In calculating the equal or up value, there are two items to keep in mind. The first is debt relief. The amount of money used to pay off debt against the property attributable to first mortgages, second mortgages, secured lines of credit, etc. is debt relief. The second is cash. The amount of debt relief, plus the amount of cash that would otherwise come to you as seller, is the target replacement value that you need to reinvest in order to defer 100% of the taxes.
Money taken out of the deal is called “boot” by the IRS and is taxable. This applies to money taken from the sale of the relinquished property and used to purchase furnishings etc. for the replacement property.
For non-residents the 15% FIRPTA withholding still applies to the sale of the relinquished property.