You’re probably already familiar with Section 1031 of the Internal Revenue Code, and it’s particularly useful to know when selling real estate. A 1031 exchange refers to the trade of one business or investment asset for another—in this case, property. If the exchange falls under certain conditions, both parties may be able to receive tax exemption for it.
Below are the conditions you’ll need to fulfill in order to receive tax exemption:
“Like-kind” refers to the requirement that the properties being exchanged should be used for the same reasons. That doesn’t mean that a single-family home can only be exchanged for another single-family home, it just means that both properties need to be either held for investment or used for trade/business. You could exchange a condo for a vacant lot, or even a commercial property for a rental property. Keep in mind that primary residences cannot be exchanged, and that both properties have to be within the U.S. border.
The IRS requires that you must identify your replacement property within 45 days of the sale of the original property, and that you must do so in writing.
Another requirement is that the purchase of the new property(s) should occur within 180 days of the sale of the original property. The new properties should have already been named during the identification period.
Third Party Intermediary
Once your original property is sold, a third-party intermediary will receive the cash—the seller can’t touch this money in between the sale of the original property and the purchase of the new property, or else the exchange will no longer qualify as a 1031. The intermediary is responsible for preparing the 1031 documents and cannot be someone the seller has a prior personal or business relationship with.
New Property Value
The value of the new property must be equal or greater to the sale amount of the old property. If there’s any cash left over, it will be taxed as ordinary income. Closing costs and commission may be deducted from the sale of the original property.