A 1031 Exchange, also known as a Like Kind Exchange, is a way of structuring a sale of certain kinds of property so that the seller’s profit or gain is not currently taxed. Instead, the property that is sold is replaced with another “like kind” property. If the transaction is properly structured, the seller’s profit or gain is deferred to a future date.

Section 1031 of the Internal Revenue Code, 26 U.S.C. § 1031, provides:

               "No gain or loss shall be recognized on the exchange of property held
                for productive use in a trade or business or for investment if such
                property is exchanged solely for property of like kind which is to be
                held either for productive use in a trade or business or for investment."

The sale of the old property and the acquisition of the replacement property do not have to be simultaneous. For a non-simultaneous exchange, the taxpayer must use a Qualified Intermediary, follow guidelines of the Internal Revenue Service, and use the proceeds of the sale to buy more qualifying, like-kind, investment or business property. The replacement property must be “identified” within 45 days after the sale of the old property, and the acquisition of the replacement property must be completed within 180 days of the sale of the old property.

Section 1031 is most often used in connection with sales of real property. For real property exchanges under Section 1031, any property that is considered "real property" under the law of the state where the property is located will be considered "like-kind" so long as both the old and the new property are held by the owner for investment, or for active use in a trade or business, or for the production of income.

In order to obtain full benefit, the replacement property must be of equal or greater value, and all of the proceeds from the old property must be used to acquire the replacement (new) property. You cannot receive the proceeds of the sale of the old property; as doing so will disqualify the exchange. For this reason, exchanges are typically structured so that your interest in the relinquished property is assigned to a Qualified Intermediary prior to the close of the sale. In this way, you do not have access to or control over the funds when the sale of the old property closes.

At the close of the relinquished property sale, the proceeds are sent by the closing agent (typically a title company or escrow company) to the Qualified Intermediary, who holds the funds until such time as the transaction for the acquisition of the replacement property is ready to close.

The prevailing idea behind the 1031 Exchange is that since you are merely exchanging one property for another property of “like-kind” there is no money received by you that can be used to pay taxes. In addition, the taxpayer has a continuity of investment by replacing the old property. All gain is still locked up in the exchanged property and so no gain or loss is "recognized" or claimed for income tax purposes.

If you are interested in learning more about 1031 Exchanges, please contact us via E-mail or telephone.