A 1031 exchange or Like kind exchange is defined by section 1031 of the Internal Revenue Code or the IRC. According to IRC if an asset, most often some form of real estate such as land or building is sold and the proceeds of the sale are re-invested in a similar asset then there is no gain or loss and the deferment of the capital gains taxes is permitted.
In order to qualify for the 1031 exchange, a set of rules is to be followed. Firstly both the relinquished as well as the replacement property must be held either for investment or for productive use in a trade or business. It is not possible to exchange a personal residence.
Secondly make sure that the nature of the assets is the same. For instance real property must be exchanged for real property and nothing else, personal property is to be traded with personal property only.
Thirdly the proceeds of the sale must be invested in a like kind of asset within 180 (property must be identified within 45 days) days of sale.
A 1031 exchange is a perfect way to suspend the taxes that are immediately due after the first sale. For instance if an investor purchases a residential property for say $250,000 and sells it for $30,000 after 5 years, the profit of $50,000 which he incurs will be subject to capital tax. But if the profit so accrued is invested in another similar kind of commercial real estate, there will be no taxation on it. So his taxes will be deferred to some date in future.
A 1031 exchange is akin to an IRA or 401K-retirement plan. When the assets are sold under the tax-deferred retirement solutions, the taxable capital gains would be kept in abeyance till they begin to cash out of the retirement plan. The tax-deferred exchanges or real estate investments also run on the same principle for till the time the money keeps on rotating i. e. re-invested in some or the other real estate, the capital gains taxes are subject to suspension.
The time an investor makes up his mind to follow a 1031 exchange, he should understand the process carefully with the help of a Qualified Intermediary. A Qualified Intermediary or an Accommodator is a corporation that performs the task of facilitating the 1031 exchanges. It is better to contact a Qualified Intermediary as soon as possible.
After you acquire complete information from the QI, display your investment property in the market. Once the offer to purchase the investment property is accepted, escrow for the sale is opened and preliminary title report is developed and produced. Following this the QI sends required exchange documents to escrow closer for signing at property closing. The moment the escrow is closed on the renounced property, according to the law within the first 45 days the investor has to identify replacement property. After a time of 180 days from the time the escrow closed, investor closes on the replacement property that was identified by him and hence the task of exchange is over.
The primary problem in 1031 exchange is the identification of the replacement property within tenure of 45 days after the sale of abandoned property. The extension to the 45 days is only on the front end and is possible with judicious planning about alternatives before the closing of the sale.
Mansi aggarwal recommends you visit 1031 exchange information for more information.