Also known as a 1031 exchange, a property exchange is a mechanism that makes it possible to purchase and sell various types of property that are of like kind. As part of the function of this like kind exchange, it is possible to ease the tax burden associated with the transaction. The provisions for a property exchange are defined in the United States by Section 1031 of the Internal Revenue Service code.
Because a property exchange makes it possible to defer some of the tax consequences associated with the transaction, the exchange can help to stimulate the economy by promoting reinvestment of any profits realized from the buying and selling of the properties. The profits or equity gained from the sale of property are used as part of the purchase of the similar property, thus offsetting the gain and lowering the tax burden. In the best of circumstances, it is possible to reinvest the full amount of the equity and thus create a situation where there is no taxable gain from the combination of transactions.
It is possible to effect a property exchange by conducting two simultaneous transactions or to delay the execution of one transaction for a short period of time. This flexibility makes it possible to arrange a reciprocal exchange between two parties, or allow for the sale of property followed with the purchase of like property from another source using the cash flow from the sale. In both instances, it is important to make sure the transactions are conducted within the provisions of the 1031 code, or the real estate exchange may result in a gain that is subject to taxes.
The end result of a property exchange may yield more benefits than simply reducing the tax burden. Often, the combination of the two transactions makes it possible to enhance cash flow for the investor while also helping to reduce the amount of management obligations involved with the property. This type of strategy can also be extremely helpful when the investor is relocating to another section of the country, as it makes it possible to sell real estate in one location while acquiring like property elsewhere without creating an additional financial burden. As long as the properties involved are similar enough to meet the government-approved definition of like-kind property, a property exchange can even help to increase the net worth of the investor without worries of additional tax burdens.
