A Tax Deferred Exchange, also known as a 1031 exchange, is a tax strategy used in the United States that allows an investor to defer paying capital gains taxes on the sale of an investment property. The Internal Revenue Code Section 1031 allows this when an investor sells a real estate property used for business or held as an investment solely for the purchase of another “like-kind” property.
Here are the basics of how it works:
- Sale of the Initial Property: The investor sells the original investment property.
- Identification of Replacement Property: After the sale, the investor has 45 days to identify up to three potential replacement properties.
- Purchase of Replacement Property: The investor must close on a new property within 180 days of the sale of the original property.
- Deferral of Capital Gains Tax: By adhering to the rules, the investor can defer the capital gains tax that would typically be owed upon the sale of the first property.
In the 1031 exchange industry, various professionals specialize in facilitating these transactions, ensuring that they comply with all legal and regulatory requirements. These may include qualified intermediaries who hold and safeguard the proceeds from the sale until they are used to acquire the replacement property. The concept behind a 1031 exchange is to allow investors to continue to reinvest in the real estate market, promoting economic activity and growth.