I have been working on 1031 exchanges for many years. Here are the basics of a 1031-
The key advantage of a Section 1031 exchange is the ability to sell a property without paying any capital gain tax, or depreciation recapture at closing, which allows the earning power of the deferred taxes to work for the benefit of the investor.
Although Section 1031 refers to “an exchange of property”, it does not require a simultaneous “swap” of properties. A Qualified Intermediary “QI” is an entity who enters into a written agreement with the taxpayer (“exchanger”) to acquire the exchanger’s rights and/or ownership interest in the property the exchanger is selling (“relinquished property”), and transfer such ownership interest into one or more properties of “like-kind” that the exchanger chooses to buy (“replacement property”). A QI is required by tax law and provides a safe harbor for the taxpayer (exchanger). I use Custom 1031 in Spokane as the QI for almost all 1031 exchanges that go through my office.
In other words, the intermediary is “assigned in” as the seller of the property during the closing process. It is the assignment that allows the seller to become an exchanger and, essentially convert an otherwise taxable sale and subsequent purchase of investment real estate into a tax-deferred exchange.
Because the intermediary is technically the seller who receives the sale proceeds, it prevents the exchanger from being in “actual or constructive receipt” of the proceeds; thus, there is nothing to tax.
To meet the requirements of §1031, both Relinquished Property and Replacement Property must qualify. In other words, both the property you are selling and the property you are buying must be qualified property of like-kind. If not, your exchange will fail and be classified as a sale.
The Internal Revenue Code requires that you identify your potential replacement properties within 45 days of the closing on the sale of your relinquished property. The 45 days are calendar days, so if the 45th day is Sunday, Labor Day or the 4th of July, that day is still the deadline for identification of new properties. There are no extensions allowed.
Basics of a 1031 Continued Will Continue tomorrow.