Another positive sign of real estate market recovery for our County is an increase in buyers and sellers utilizing a 1031 exchange. During the recession when appreciation was non-existent there were no gains for buyers and sellers to defer. Many sellers decided to hold off and wait for more recovery.

As a 1031 exchange is a handy tool for deferring income tax on the sale of real estate, I thought you might desire more details about the program. As typical for any IRS code, the description material tends to be dry so reading this article may function as a sleep aid as well.

What is an IRS Section 1031 Tax Deferred Exchange? Quite simply, it allows you as the owner of investment property (almost all property that is not your personal residence or second home) to sell your property and buy another investment property, deferring the tax on your capital gains. You do not have to find someone to accept your property in trade for the one you buy.

The steps for performing an exchange are not significantly different from those for completing a standard sale. You list the property, hopefully with me, and then market it for sale just like any other property. A Buyer is located and escrow is opened. An Intermediary is brought into the transaction prior to closing. Suitable replacement property is purchased and the exchange is concluded.

When considering the sale of income or investment property, you as a seller must consider the taxation. When selling property you could owe federal and, in some areas, state capital gains tax. This could mean paying 15% to 40% in taxes on the gain. Instead of paying a large amount to the IRS in taxes you can use that money to buy more real estate. Property that qualifies for preferential tax treatment under Internal Revenue code section 1031 (IRS 1031) is treated quite differently. IRS Section 1031 states:

“No gain or loss shall be recognized if property held for productive use in a trade or business or for investment purposes is exchanged solely for property of a like-kind”. Investors do not have to exchange for exactly the same type of property as they relinquished. “Like-Kind” does not refer to the nature, character or type of property but just that it also be held for productive use or for investment purposes.

Therefore, if using IRS section 1031, you can exchange raw land for a rental home, an apartment complex, or for a shopping center. The use of the property is the factor in determining the tax treatment. Provided the property is initially acquired and held for either business or investment purposes, it can qualify as a suitable replacement property.

You must trade “equal or up” in equity and value to completely defer taxes. If you dispose of a property at one value and acquire another property at a lesser value, taxes are due on the difference.

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