A wise investor’s vehicle for deferring capital gains taxes or depreciation recaptures, 1031 exchanges were first adopted by the IRS in 1954. That’s when the present day definition of a like-kind exchange was adopted. Decades later, there are still many misconceptions about how these exchanges work.
• Like-kind means “exactly the same.”
The IRS requires that like-kind property be “of the same nature, character, or class.” That doesn’t mean they need to be exactly the same. You can exchange gains from sale of an apartment building into shares of a net-lease property, or a piece of land for a multifamily property.
• To participate in a like-kind exchange, I need to find someone to swap property with.
This is actually how original exchanges were structured, but you are currently free to sell your property to anyone who is interested in buying it, and to buy from anyone who is selling a like-kind property.
• I can’t buy a new property until I sell my original property.
This is the way most property exchanges are structured, but in a reverse exchange, you buy the new property before you sell the one you are relinquishing.
• The sale and purchase have to happen at the same time.
The IRS allows the taxpayer 45 calendar days from the sale of the relinquished property to identify replacement properties, and 180 calendar days after the sale to close on the replacement property.
• All of the money from the sale of my property has to be reinvested.
The IRS allows taxpayers to buy down in value, or to withhold funds in an exchange. Just be aware that any funds that are not reinvested will be considered boot and will most likely be subject to tax.
• The exchange has to be equal: 1 property for 1 property.
Taxpayers are allowed to sell a single property and exchange it with multiple properties, or vice versa.
• Only big companies and investors can take advantage of 1031 exchanges.
Any taxpayer who owns business or investment properties that qualify under IRS guidelines can take advantage of a 1031 exchange.
• A Qualified Intermediary is not necessary.
A Qualified Intermediary is not required by the IRS, but a QI is essential in order to avoid the difficulties often associated with these complex transactions. The IRS allows the QI to sell the property and collect funds from that sale, then to use those funds to purchase replacement properties. It’s important to note that the QI cannot be anyone who has acted on behalf of the taxpayer for a two-year period, including but not limited to the taxpayer’s accountant, attorney, investment banker, or real estate broker.