What is a 1031 Exchange?

A 1031 Exchange, also known as a like-kind exchange or tax deferred exchange, is where real property that is “held for productive use in a trade or business or investment” is sold and the proceeds from the sale are reinvested into a like-kind property intended for business or investment use. A 1031 Exchange allows the taxpayer, or seller, to defer the capital gains tax and depreciation recapture on the transaction.

The property sold as part of a 1031 Exchange is called the Relinquished Property. The property purchased is the Replacement Property. The real property in a 1031 Exchange must be like-kind; most real estate is like-kind to all other real estate. For example, an office building could be exchanged for a rental duplex, a retail shopping center could be exchanged for farmland, etc. To help understand whether real property is like kind, ask yourself, is the intent and use of the replacement property the same as the relinquished property.

During a 1031 Exchange, neither the taxpayer nor an agent of the taxpayer can receive or control the funds from the sale of the property. If a taxpayer has direct or indirect access to the funds, a 1031 Exchange is no longer valid. That is why a Qualified Intermediary is used to hold the proceeds of the Relinquished Property sale until it is time to transfer those proceeds for the close of the Replacement property. Without a Qualified Intermediary, the 1031 exchange fails!

To be eligible for a 1031 Exchange, the person or entity must be a US tax paying identity. This includes individuals, partnerships, S-corporations, C-corporations, LLCs, and trusts. However, it is a requirement that the same taxpayer sells the relinquished property and purchases the replacement property for a valid exchange.

If you’d like to read more about 1031 rules, you can do so here. If you need a 1031 third party servicer you can reach out to 1031 Prime here.

*the above does not constitute tax or legal advice. Please reach out directly to your advisors for guidance on your specific situation.