The Basics Of 1031 Exchange

Many homeowners have heard of a “1031 Exchange,” but few understand the basics of what an exchange actually entails. I will cover a few of the basics of the process, as it is an invaluable method of homeownership for investment homeowners.

1031 Exchange, what is it?

Put simply, it is the sale of one property in exchange for the purchase another property of similar value without the required payment of capital gains tax, all performed within a specific time frame. An example of when you might use a 1031 Exchange, as opposed to selling a home and purchasing a new one outright: you want to sell your current home and purchase a new, similar one that has a few better features. You have not yet owned your current vacation home for two years, so you are subject to substantial capital gains taxes when you sell it. If you used 1031 Exchange, you could “exchange” your current home for a new one and be free of the capital gains requirement. It is this difference between “exchanging” and not simply buying and selling which, in the end, allows you, the taxpayer, to qualify for a deferred gain treatment. In a nutshell: sales are taxable with the IRS and 1031 exchanges are not.

Important Rules of 1031 Exchange

1. The purchase price of the replacement “like kind” property must be greater than or equal to, the total net sales price of the relinquished, real estate, property.

2. All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, “like kind” property.

1031 Timelines and Rules

Identification period – the seller has exactly 45 days from the sale of the original property to identify other replacement property(s) that he proposes or wishes to buy.

Exchange period – the period during which the seller of the relinquished property must receive the replacement property. The period ends on the due date of the taxpayer’s return for that taxable year or 180 days after the date on which the taxpayer transfers the property, whichever happens first.

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