What is an IRC Section 1031 Exchange?

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An Internal Revenue Code Section 1031 Exchange allows taxpayers the opportunity to sell investment property, reinvest the proceeds and defer the capital gains tax.  Section 1031 Exchanges have been part of the tax code since 1921.  A 1031 exchange allows investment property owners to exchange business or investment property for other like kind business or investment property without recognizing the taxable gain on the sale of the old assets.  The taxes which would have been due from the sale are deferred.  The Internal Revenue Service has set out very specific guidelines that must be followed to ensure a successful exchange.

• Properties being sold in a 1031 exchange must have been held as business use or investment property, i.e. rental property, commercial property or vacant land.  The replacement property must also be business or investment use property.  Primary residences, second homes, flips, new construction or development projects are not eligible for a 1031 exchange.
• The title of the relinquished property and the replacement property must be in the same taxpayer’s name
• The exchangor must initiate the 1031 exchange with a qualified intermediary (like MidSouth Exchange, Inc.) prior to the purchase or sale of any properties involved in the exchange.   
• The exchangor cannot be in constructive receipt of the proceeds from the sale. The proceeds from the sale of the relinquished property must be held by a qualified intermediary during the duration of the exchange.
• Timelines are crucial to a successful 1031 exchange.  The timeline begins on the closing date  of the sale property.  The exchangor has 45 days to identify any property that will be purchased and 180 days to close on all replacement properties.
• To defer 100% of the capital gains tax, the Exchangor must use all the proceeds from the sale of their relinquished property in the purchase of the replacement property.  Any debt that existed on the relinquished property must also be replaced by new debt or cash from outside the exchange.  If a portion of the funds from the sale of the relinquished property is taken as cash or is left unspent at the end of the exchange, it is subject to capital gains tax.