Monday, December 11, 2023

What is a 1031 Exchange?

What is a 1031 Exchange?  


Internal Revenue Code Section 1031 permits the deferral of capital gains on the sale of property held for investment or productive use in a trade or a business

1031In a Forward Delayed Exchange, the most common type of Exchange, property is sold (Relinquished Property), and the proceeds are used to purchase another property (replacement Property) within certain timeframes. To qualify for safe harbor tax deferral, the sale proceeds must be held by a Qualified Intermediary between the sale of the Relinquished Property and the purchase of the Replacement Property.

A 1031 Exchange permits deferral of federal capital gains taxes (15%), depreciation recapture taxes (25%), and state taxes (generally 8% to 9% where applicable).

In the midst of an exchange, can Exchange funds be returned to the taxpayer? Yes, however, strict limitations exist. Pursuant to I.R.S Reg. 1.1.03(k)-1(g)(6), every 1031 exchange Agreement must include language limiting a taxpayer’s right to access exchange funds before a Replacement Property is not identified, Exchange funds can be returned on the 46th day. If Replacement Property is identified, the Exchange period ends when the last of the identified Replacement properties is purchased or on the 181st day, whichever happens first. Funds can be returned to the taxpayer thereafter.