1031 Exchanges
1031-EXCHANGE DEFINITION
The term 1031 Exchange is defined under section 1031 of the IRS Code which allows an investor to “defer” paying capital gains tax on an investment prop- erty when it is sold, as long another “like-kind property” is purchased with the profit gained by the sale of the first property. There are a few different types of the 1031 exchange although we recommend speaking to an accountant or exchange facilitator before deciding on which one will work best for your investment future.
To qualify an investment sale for a deferment of capital gains tax, one must follow a few simple rules.Downleg
Refers to the property being sold
Upleg
Refers to the property that the exchange recipient will exchange into
RULE 1
The property must be a like-kind property – meaning it must be the same nature or character, even if they differ in grade or quality. For example, you can’t exchange farming equipment for an apartment building.
RULE 2
The exchange property must be of greater or equal value – meaning the IRS requires that the net market value and equity of the property purchased must be the same as, or greater than the property sold. Otherwise, you will not be able to defer 100% of the tax. For example, if you plan to sell a property that is valued at $1,500,000 with a mortgage of $500,000, the new property you purchase must have a net worth of at least $1,500,000.
RULE 3
the exchange recipient must also replace any debt that they had on exchange property. Referring to the previous example, the exchange recipient would need to replace their previous mortgage of $500,000.