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1031 Exchange

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Considering the rules and regulations involved, it is highly recommended that investors work with a professional with experience in 1031 exchanges to ensure the process is handled correctly. Let Drake Estates be that professional!

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What is a 1031 Exchange?

A 1031 exchange in real estate — also called a like-kind exchange — is a type of tax-deferred exchange that allows real estate investors to defer capital gains taxes when selling one investment property for another. A 1031 exchange is named after the Section 1031 provision in the IRC tax code.

This exchange involves using the proceeds from the sale of the relinquished real estate investment property to acquire another like-kind piece of real estate. The new property has to be of equal or greater value than the one that is sold, and all of the cash profits must be reinvested. This is the only way to defer 100% of the tax on the gain of the sale.

There are plenty of reasons to do a 1031 exchange and open up new opportunities for property ownership. Here are just a few situations in which a 1031 exchange may be an excellent choice for you:
  • Exchange existing property for property with better long-term prospects
  • Exchange existing property for property that will diversify your assets
  • Exchange property you manage on your own for already managed property
  • Exchange multiple properties for one
  • Exchange one property for multiple ones
  • Exchange properties to reset depreciation
  • Expand real estate holdings for the sake of inheritances
By completing the exchange, the taxpayer can build wealth, maximize their purchasing power for replacement properties, save taxes normally due upon the sale, and dispose of investment assets to acquire new ones. To reap the benefits of this practice, investors must identify and close on the replacement property within a specific time limit.

Of course, the goal of a 1031 exchange is 100% tax deferral, but this requires investors to put all of the proceeds from the sale of their relinquished property toward the exchange property. With a partial exchange, investors can keep some of the proceeds and pay some of the capital gains taxes owed. The proceeds kept are called boot. In most cases, investors aim to avoid boot to prevent tax liabilities and gain the full benefits of a 1031 exchange.

The Internal Revenue Service (IRS) has established rules that limit the use of these properties for business, investment, and trade purposes only. For instance, a taxpayer cannot exchange their rental unit property for a personal vacation home. A 1031 exchange may also be referred to as a Starker exchange or used as a verb, such as saying, “We should 1031 that building for this one.”

With a 1031 exchange, investors can use the delayed method — selling their former property before acquiring the replacement — or they can swap them at the same time. This is known as a simultaneous tax-deferred exchange. In this process, the taxpayer closes on the relinquished property and the replacement property on the same day.

Considering the rules and regulations involved, however, it is highly recommended that investors work with a professional with experience in 1031 exchanges to ensure the process is handled correctly.