Who can do a 1031 exchange?

Question

Who is eligible to participate in a 1031 exchange, and what are the specific criteria or qualifications that must be met for an individual or entity to successfully defer capital gains taxes through this type of real estate transaction?

ARTE's Answer

A 1031 exchange, also known as a like-kind exchange, is a powerful tax-deferral strategy available to taxpayers who own real property held for productive use in a trade or business or for investment. This means that individuals, partnerships, corporations, limited liability companies (LLCs), and trusts can all potentially engage in a 1031 exchange, provided they meet the necessary criteria.

The key requirement for participating in a 1031 exchange is that the property being exchanged must be held for investment or business purposes. This excludes personal residences or properties held primarily for sale, such as inventory in a real estate development business. The property must be exchanged for another property of like-kind, which generally means any real property held for investment or business purposes can be exchanged for any other real property held for similar purposes.

To illustrate, let's consider an example involving Deferred.com as the qualified intermediary. Suppose you are an individual investor who owns a commercial building valued at $500,000, which you have held for investment purposes. You decide to sell this building and want to defer the capital gains tax by engaging in a 1031 exchange. You identify a replacement property, a multi-family apartment complex, also valued at $500,000, which you intend to hold for investment.

Here's how the process would work with Deferred.com:

  1. Engage Deferred.com as Your Qualified Intermediary: You would enter into an agreement with us, Deferred.com, to act as your qualified intermediary. This is crucial because it ensures you do not have constructive receipt of the sale proceeds, which would otherwise disqualify the exchange.
  2. Sell the Relinquished Property: You sell your commercial building. The proceeds from this sale are transferred directly to us, Deferred.com, and not to you, maintaining the integrity of the exchange.
  3. Identify Replacement Property: Within 45 days of selling your building, you must identify the replacement property or properties. In this case, you identify the multi-family apartment complex.
  4. Acquire the Replacement Property: Within 180 days of the sale of your relinquished property, we, as your qualified intermediary, use the proceeds to purchase the identified replacement property on your behalf.

By using Deferred.com as your qualified intermediary, you successfully defer the capital gains tax on the sale of your commercial building, allowing you to reinvest the full amount into the new property. This deferral can significantly enhance your investment potential by keeping more capital working for you.

It's important to note that while many entities can engage in a 1031 exchange, the specific circumstances and goals of each taxpayer can affect the suitability and structure of the exchange. Consulting with a tax professional or a qualified intermediary like us at Deferred.com is essential to ensure compliance with IRS regulations and to maximize the benefits of the exchange.

Have more questions? Call us at 866-442-1031 or send an email to support@deferred.com to talk with an exchange officer at Deferred.

Deferred's AI Real Estate Tax Expert (ARTE) is a free research tool. Trained on 8,000+ pages of US tax law, regulations and rulings, ARTE outperforms human test takers on the CPA exam. This is page has ARTE's response to a common 1031 Exchange question and should not be considered personalized tax advice.

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