1031 Exchanges

A “1031 exchange” refers to a method of deferring tax on the sale of an interest in real property allowed under section 1031 of the Internal Revenue Code. In brief, it allows a seller to defer tax on a gain that would otherwise be realized on a sale of property if the proceeds from the sale were reinvested in like-kind property. It’s quite common for a 1031 exchange to be involved in some manner in a commercial real estate transaction.

The Internal Revenue Code imposes taxes when property is sold or transferred and a gain is realized. According to Section 1031 of the tax code, if a taxpayer adheres to strict code guidelines, then all or a portion of the gains from the disposition of business or investment property can be deferred or reinvested into a new replacement property.  These 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 tax deferment, the taxpayer must structure the transaction as an exchange of one property for another of "like kind".  A seller must contractually arrange to convey his or her interest in the property being sold in exchange for receiving an interest in another piece of commercial property. If cash is involved, an escrow company or facilitator usually it, because treatment under section 1031 won’t be possible if the proceeds are paid to the seller even for an instant. In practice, however, the rules for a 1031 exchange can be quite complex and it is easy for a seller to run afoul with them. It’s always advisable to have competent legal counsel involved in the transaction.

(Read Section 1031)