A 1031 real estate exchange is a process by which real estate changes hands, but in a way that is not subject to capital gains taxes in the United States. The exchange is seen as a very profitable way to exchange real estate, yet avoid taxes and some real estate investors use it often. However, there are strict rules associated with a 1031 real estate exchange.
There are certain transactions which are not covered by the rules of a 1031 real estate exchange. Those who are depending on the provision should contact a tax professional, perhaps even a tax attorney, before engaging in the exchange. One of the main rules is that private property held for personal use cannot be exchanged under this provision. However, there may be some other exemptions for private property covered under other portions of the US tax code.
A 1031 real estate exchange applies only to properties that are held as investment opportunities, usually commercial endeavors. Also, the provision does not apply to cases where a property is sold and another property is bought. It is usually only for exchanging property for property and the property must be classified as like-kind.
Though the definitions of like-kind property may be complex, the basic premise of the 1031 real estate exchange demands that it must involve investment properties. This could be exchanging an apartment complex for a shopping center, or a shopping center for a patch of undeveloped real estate, as just a couple of examples. However, if any money is exchanged in addition to land, or any other type of non like-kind property, then the entire transaction will be subjected to taxes.
In the normal course of business, without a 1031 real estate exchange provision, money may change hands between two property holders. One would pay money for one property and it may be turned around and paid back for another similar property. However, in between those times, the cash would be subject to capital gains taxes, making the entire transaction more expensive and less attractive. A 1031 real estate exchange is a good way to provide an incentive for re-investment.
In addition to rules for like-kind property, other rules are also in place for a 1031 real estate exchange. One of those is the fact that once the first property is transferred, the other property must be transferred within 180 days. A replacement property must be identified within 45 days. Not meeting these timing provisions could subject the entire exchange to capital gains taxes and the Internal Revenue Service makes no exceptions.