The IRC §1031 tax deferred exchange allows a real estate investor to defer capital gains tax they would have recognized when they sold their investment real estate. The exchange part allows that investor to reinvest money into a new investment property/s that would otherwise have been paid to the government as a capital gains tax. Tax deferred exchanges are not new — they have been available in one form or another for more than a century, with a lively history to match.

So, an exchange is a structured sale and purchase of real estate with the inclusion of a qualified intermediary (QI) to structure the transactions as a 1031 exchange. To receive the tax deferral, the investor must follow a series of rules and timelines, guided by the QI.

1031 EXCHANGE RULE

To qualify for an IRC §1031 tax deferred exchange, real property must be held for productive use in a trade or business or for investment purposes (investment property).

To complete a valid deferred exchange, prior to the sale of relinquished property, the taxpayer must engage a Qualified Intermediary (QI) to prepare the legal documents necessary for the exchange.

To defer capital gains, the replacement property must be of equal or greater value than the sold/relinquished property (less allowable closing costs). The exchanger must replace all the equity and obtain equal or greater financing on the replacement property as was paid off on the relinquished property. If less financing is used, additional cash can be added to replace some or all the debt. The taxpayer must receive nothing but like-kind property (investment property for investment property).

The taxpayer selling the relinquished property must be the same taxpayer purchasing the replacement property (the same EIN or social security number).

The replacement property/s must be identified within a 45-day identification period (calendar days) after the closing of the sold/relinquished property.

The exchanger needs to purchase one or more identified properties within 180-days from the sale of the relinquished property

All the proceeds from the sale of the relinquished property must be received directly by the Qualified Intermediary and held in escrow, until the exchange is completed, or the exchange will be void and capital gains tax will be due on the sale.