1031 Exchange Basics (Part 1 of 2)

The 1031 exchange is a popular tool used to defer capital gain taxes (or losses) for business and investment real estate transactions. It is derived from the Internal Revenue Service’s code Section 1031 and gives investors the opportunity to earn a rate of return on funds that would otherwise be paid to the IRS.

It is also great for portfolio adjustments: diversify, expand, risk averse, down size, location selection, etc. These details can be very important and help with major investor and business owner decisions. To start off, we will go over the types of 1031 exchanges:

Simultaneous Exchange

The investor will exchange into the replacement property immediately after the closing of their original property (the “relinquished property”), usually happening within one business day. During a simultaneous exchange, the investor is not required to use a Qualified Intermediary to handle the funds.

Deferred or Delayed Exchange

Once the deed is transferred on the relinquished property, the investor gets put on the clock to identify and close on the replacement property. The closing of the replacement property must occur within 180 days.

The replacement property must be identified within 45 days from the closing of the relinquished property.

Build-to-Suit (Improvement or Construction) Exchange

Using the exchange proceeds, the taxpayer is allowed to build and/or make improvements to the replacement property.

Reverse Exchange

The replacement property is acquired before the disposition of the relinquished property. After the acquisition of the replacement property, the investor has 180 days to close on the relinquished property.

These are great ways to defer capital gain taxes when making investment and business decisions. In the next write-up, I’ll go over the rules and regulations of a 1031 exchange. Stay tuned.