A 1031 exchange, or exemption, allows commercial investors to defer property sales taxes in certain cases. The 1031 exemption is often used when an investor intends to sell one piece of commercial real estate in order to acquire a separate, but similar, piece of property.

The 1031 exchange applies only if the relinquishment and acquisition are mutually dependent on one another. There is no tax deferment in the event an investor simply sells a property and later uses those proceeds to purchase additional commercial properties.

An Overview of the 1031 Exchange: IRC Section 1031

The 1031 exchange was written into the Internal Revenue Code (IRC) at the Code’s inception in 1921. However, it did not become a widespread practice until the 1990s when the Omnibus Budget Act simplified the code. This made it a more accessible—and known—option for those who may not otherwise deal with complex tax codes on a day-to-day basis.

The 1031 exchange allows you to postpone paying taxes to the Internal Revenue Service on an investment property for which you have experienced a financial gain. This applies only if you reinvest the gain in purchasing or financing a similar property. This is considered a “like-kind” exchange.

The 1031 exchange is a tax-deferment. It does not mean the sale and purchase are considered “tax free.” In fact, some gains that occur during the course of a 1031 exchange may be considered taxable at that time. For instance, you may still have to pay gain taxes on cash or other property that does not fall under the umbrella of the “like-kind” transfer.

Those Who Qualify for the 1031 Exchange

The 1031 exemption applies only for those dealing with commercial or investment properties, qualifying parties may include:

• investment property owners;
• business property owners;
• individuals;
• C corporations;
• S corporations;
• general partnerships;
• limited partnerships;
• limited liability companies (LLC);
• trusts; and
• other taxpaying entities permitted to deal in business or investment properties under the terms of IRC Section 1031.

The 1031 exchange is not appropriate for use by a homeowner selling or purchasing a personal residence.

Special Considerations with a 1031 Exchange

Investors typically use a Qualified Intermediary when using the 1031 exchange. This is an independent third party who may act as the “safe harbor” for exchanged properties. Examples of a Qualified Intermediary include an escrow holder or other facilitator. Your accountant or personal attorney cannot function as your Qualified Intermediary. You must select a professional with whom you have not had a business relationship for the previous two years.

Time is of the essence during a 1031 exchange. You have just 45 days after the sale of your property in which to identify the replacement property. You have 180 days from the date of sale in which to close on the replacement property.

Call (312) 775-0980 if you are concerned about how to protect your property from foreclosure or other financial uncertainties.