A 1031 exchange, also known as a “like-kind exchange,” allows an individual to defer paying capital gains taxes on the sale of an investment property by using the proceeds to purchase another “like-kind” investment property. This deferral is allowed under Section 1031 of the U.S. Internal Revenue Code.
Here’s the process:
- Identify a property to sell (the “relinquished property”).
- Identify a replacement property to purchase (the “replacement property”).
- Notify the seller and buyer of the intent to complete a 1031 exchange.
- Close on the sale of the relinquished property and the purchase of the replacement property within the specified time frame (usually 180 days).
- Place the proceeds from the sale into a qualified intermediary‘s account.
- Use the funds from the qualified intermediary’s account to purchase the replacement property.
By completing a 1031 exchange, the investor is able to defer paying capital gains taxes on the sale of the relinquished property until they sell the replacement property in the future. This can result in significant tax savings, as the deferred taxes are compounded over time.