Internal Revenue Code 1031 refers to the Internal Revenue Service code that defines and governs the occasions under which a property can be sold, without having to pay capital gains, by exchanging that property for another. Capital gains tax is a form of taxation that occurs when assets are sold. If the asset is sold for more than the price at which it was purchase, taxes are calculated on the difference between the two and this is called capital gains tax.
Tax payers have long complained about capital gains and the way in which it undermines the value of an asset. It is particularly bothersome for those who need to sell property in order to diversify their portfolio. A 1031 Exchange allows a property holder to defer the tax when he buy a new “like kind” property with the proceeds from the sale of the existing property.
Guidelines for exchanges
There are numerous rules that must be followed in these exchanges. For example, properties must be “like kind.” The definition of “like kind” property is more liberal for business property than it is for private property. What is true in both cases is that like kind is understood to property that is the same; so, for example, office space can be exchanged with office space, but not with a fleet of buses). With business property (for example, real estate or fleets or large equipment), the definition is more liberal. Businesses can conduct exchanges of property without regard for the similarities in the class of the property. So, for example Class A office space could be exchanged for Class B office space.
With individual property, there are more restrictions. Property that is exchange must be of a similar class or grade in order to qualify for the tax treatment.
There are also strict timing guidelines; specifically there are critical 45-day and 180-day deadlines associated with transactions. In order to get the tax benefit, the replacement property must be identified within 45 days after the close of the sale of the relinquished property. Further, the acquisition of the new property must be completed within 180 days of the close of the sale of the relinquished property.
Exchange service providers
In order to qualify for the tax benefit, funds held from the sale of the relinquished property must be held by a third-party Qualified Intermediary (QI). QIs, or 1031 Exchange Services, are often subsidiaries of larger title or insurance companies, though some are also smaller organizations. Some operate only within one or two states, while others have national operations.
Though necessary part of the process, not all QIs are created equal. Those considering doing an exchange should look for certified exchange facilitators. They should also understand how the company protects funds on deposit.
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