1031 Tax Deferred Exchange Basics

Posted on 15. Mar, 2009 by Kui Team Staff

What is a 1031 Exchange?
A 1031 Tax-Deferred Exchange, also known as a “Starker” or “Tax-Free” exchange, is one of the few remaining tax shelters allowed by the IRS. A 1031 Exchange is a way to avoid paying taxes on the gain by re-investing those gains from the sale of your investment property.

What this means is that you as the taxpayer can sell your property, and use that money to purchase another property of “like kind”. Using an “intermediary” who is used to hold the funds from the sale of your property, once you find the like-kind property to purchase, your funds are then used towards the purchase of the new property. There are many companies that offer this service and will act as the intermediary for a fee, usually around $1000.

Any real property (apartment complexes, office buildings, raw land, homes, multi-family homes, etc…) held as an investment qualifies for an exchange. Although 1031 Exchanges are not for use with your primary residence, in some cases the first $250,000-$500,000 of your gain of your home will be tax-free. You are required to re-invest the full sales price of your home, not just the gain, however you may re-invest the monies into multiple properties as long as the total collective price of all properties meets or surpass the sales price of the property you are selling.

The IRS did put specific guidelines on this that state that you have 45 days upon the closing of your sale to identify the property that you intend to purchase. What constitutes “identifying” can change depending on who you ask.  The best way to “identify” is to use an intermediary and submit in writing the selections you have chosen as your replacement properties.

You can choose up to three properties, regardless of value, or you may choose countless properties you like, as long as the combined value of all the properties acknowledged does not exceed 200% of your surrendering property. There is an exception that is called the 95% Exception Rule: This rule is automatically applied if neither of the above rules apply. Purely stated, the exchanger must obtain 95% of what was identified! This is the rule that the IRS uses to keep people from identifying an over abundance of potential properties!

The time frame in which you have to complete the purchase of the replacement property is six months from the date of the closing of your relinquished property.

This IRS offers a website with a lot of information on the 1031 Exchange, and there are also a number of internet-based intermediary companies which offer a collection of useful information. We would like to give you a word of caution here: we highly recommend using a 3rd party accommodator.