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Deferring Taxes with a 1031 Exchange

April 17, 2017

 

A 1031 exchange, also known as a like-kind exchange.  is a swap of a property held for "productive use or investment" for property of a like-kind. Property is of like-kind if it is the same type of investment. For example, farm land is often exchanged for other farm land. It could also be certain kinds of livestock for other kinds of livestock or an apartment complex for a commercial building. Usually, an exchange of property will result in a taxable event, but by falling under Section 1031 of the Internal Revenue Code, the event is not taxable and any gain is deferred. 

 

A simple example of a 1031 exchange would be when two farmers decide to swap land. To the extent that the farms are roughly equivalent in value, the exchange does not result in a taxable event. However, when a farmer needs to add some cash to the transaction because the properties are not equal in value (known as "boot"), that part is taxable. 

 

A more common scenario for a 1031 exchange is when a farmer identifies a farm he would like to purchase. In order to purchase the farm, the farmer will be selling a different farm. Any gain the farmer receives on the sale of the farm he already owns would normally be taxed at the farmer's capital gains rate. Instead, the farmer uses a 1031 exchange so that the proceeds of the sale are deposited with a Qualified Intermediary, who then transfers the funds to the seller of the new farm. If done properly, the farmer defers any capital gains and does not pay tax on the sale. 

 

While a 1031 exchange can be a great tax planning tool, there are a few critical aspects to a 1031 exchange:

  • First, you must contact a Qualified Intermediary before the sale of property. 

  • You cannot touch any of the cash from the sale of property. 

  • You have 45 days from the sale of property to identify a replacement property.

  • You have 180 days from the sale of property to purchase the replacement property. 

The attorneys at Ward & Oehler regularly advise buyers and sellers in real estate transactions and can serve as a Qualified Intermediary for 1031 exchanges. For questions or more information, Contact Us.    

 

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