Section 1031 of the Internal Revenue Service Code provides that a real property owner who sells his property and then reinvests the proceeds in ownership of like-kind property is able to do so and defer any capital gains tax. However, to qualify for this tax treatment, certain IRS and Treasury rules must be followed.
What are the rules?
There are five basic rules to follow on all 1031 exchanges:
1
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Exchange like for like. The property sold must be investment property, used for trade or business purposes, or for the generation of income.
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2
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Exchange even or up in both net equity and net value.
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3
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Identify acceptable property within 45 days of the sale date. |
4
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Acquire replacement property within 180 days of the sale date, or before filing a tax return for the year of the sale. |
5
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Use a qualified intermediary. This third party holds and disburses funds for the benefit of the exchangor.
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The biggest advantage is the leverage provided by the deferral of taxes. However, equally important to some, is the multigenerational aspect. Based on current tax laws, an investor may leave his investment property to heirs, who will receive a stepped-up basis for the property. If the heir sells at time of acceptance, he or she will not be taxed if sold at the stepped-up basis.
