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Internal Revenue Code Section 1031 Tax-Deferred Exchanges

In general, the Internal Revenue Code imposes taxes when property on which there is a gain is transferred.  However, Section 1031 of the Code is an exception to this general rule, allowing 100% of the gains from the disposition of business or investment property to be deferred into new replacement property. T hese deferred gains, as well as the gains from the new property, are not taxed until the new property is transferred and fails to qualify for tax deferral.

To qualify for this deferral, strict adherence to Section 1031 and all of its rulings is imperative.  Therefore, taxpayers must structure the transaction as an exchange of one property for another of “like kind,” as opposed to a sale for cash or other non-like kind property and then reinvestment into new property.

The 1031 Financial Advantage:  Leverage

When the tax liability in a transaction is deferred, the taxpayer receives an increase in available capital that can be applied to the acquisition cost of the replacement property.  This is how deferring taxes with a Section 1031 exchange provides the power of leverage.  An investor not paying taxes has more buying power than the one paying taxes, with the potential to increase appreciation, cash flow, and tax benefits.

The 1031 Strategic Advantage:  Flexibility

There are many investment strategies the taxpayer can employ utilizing Section 1031.  Here are a few examples:

  • Consolidate many properties into one for ease of management.
  • Diversify one into many for ease of future divestment.
  • Relocate properties geographically to take advantage of trends.
  • Change property taxes (real estate exchanges only).
  • Improve investment performance.
  • Adapt to changes in needs and abilities, and other life transitions.
  • Replace older properties with newer ones.
Nine Easy Steps to Tax Deferral

Most exchanges, whether simultaneous or delayed, involve three (3) parties:  the taxpayer (exchanger), the buyer who is acquiring the taxpayer’s old property (relinquished property), and the seller who is selling to the taxpayer a new property (replacement property).  To realize all of the benefits of a 1031 tax deferral, the taxpayer must add a fourth party:  a qualified intermediary who facilitates the transfer of the properties and retains control of the funds pursuant to IRS-prescribed safe harbors.  The process (except for reverse exchanges) follows these nice simple steps:
  1. Tax Advisor:  The taxpayer should consult with a tax or financial advisor to determine if a tax-deferred exchange is appropriate and is compatible with overall investment goals.
  2. Contract of Sale:  The taxpayer signs the contract to sell the relinquished property to the buyer.
  3. Contact LandAmerica 1031 Exchange Services:  When escrow is opened on the relinquished property, the taxpayer contact a LandAmerica 1031 office to set up and execute the Exchange Agreement.  The Exchange Agreement must be executed before the first transfer of the first relinquished property.
  4. Closing Relinquished Property:  At transfer of the relinquished property, LandAmerica 1031 directs transfer of title to the buyer and the sale proceeds are delivered to LandAmerica 1031.
  5. Timing:  To effect a deferred exchange, the relinquished property must transfer before the replacement property is acquired.  (However, with the favorable IRS Revenue Procedure 2000-37, it is now permissible to do a reverse exchange by acquiring the replacement property prior to the transfer of the relinquished property to a buyer.  Reverse exchanges must be structured with different documents.  Please contact a LandAmerica 1031 office for more information on reverse exchanges and request a copy of our booklet, 1031 Reverse Exchanges.)
  6. Identification Deadline:  Within 45 days of transfer of the relinquished property, the taxpayer notifies LandAmerica 1031 in writing (forms provided), of the identified replacement properties.
  7. Notification:  The taxpayer notifies LandAmerica 1031 when identified property(ies) are contracted for purchase and escrow is opened.
  8. Acquisition Deadline:  The taxpayer closes escrow on the replacement property within 180 days from the transfer of the relinquished property.  Note:  Taxpayer should not file a tax return while exchange is pending.
  9. Enjoy:  The taxpayer enjoys the benefits of tax-deferred savings!