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What is a 1031 Tax Exchange?

2022/09/07

What is a 1031 Tax Exchange?

According to the Internal Revenue Service (IRS), a 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code. Simply put, a 1031 exchange is a tax deferral. However, it doesn’t mean tax-free. This may seem confusing, but the staff at AFM Real Estate are ready to help you unpack requirements, benefits, and the most common type of exchange called the “forward exchange.”

1031 Exchange Requirements
Here are some of the basic qualifications for a 1031 exchange:
• The real estate must be used for investment or business purposes
• The real estate must be owned by individuals, C corporations, S corporations, partnerships, limited liability companies, or trusts
• The new land or replacement investment must be “like-kind,” meaning they are of the same nature or character. 1031 now only applies to real property, but nearly all types of real property are considered like-kind to each other.

Examples of Qualifying Properties
• Raw land, including timberland, ranch land, and farms
• Oil and gas royalties
• Residential, Commercial, Industrial, or Retail property
• Mitigation credits for restoring wetlands

1031 Exchange Benefits
There are several benefits to a 1031 tax exchange. Here are a few examples:
• When purchasing new like-kind property, the capital gains tax is deferred
• The money saved from deferring the capital gains tax can be used in the new investment, thus allowing you to build more wealth
• Your new purchasing power allows you to diversify your assets, even across state lines or market areas

The Forward Exchange
A 1031 forward exchange means the seller has relinquished or sold one property before purchasing another. Here are some additional details regarding the forward exchange:
• The sales from the relinquished property will be held in an escrow account by a Qualified Intermediary (QI) until the new property is purchased
• The buyer enters a 45-day identification period, and three replacement properties must be identified during that time with the intent to purchase at least one
• The buyer must close on the replacement property within 180 days or 135 days after the end of the identification period; otherwise, the 1031 exchange is void, and the taxpayer owes federal taxes on the sale of the relinquished property

As you can see, there are some strict rules and requirements. We have worked through many transactions with 1031 exchanges at AFM Real Estate, assisting buyers seeking replacements or assisting sellers with relinquished property sales. Contact one of our AFM Real Estate agents to discuss how we can help you with your land purchase or sale needs.

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Frequently Asked Questions

  • A 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code. Simply put, it is a tax deferral on capital gains when you sell an investment or business property and reinvest the proceeds into a like-kind replacement property. It is important to understand that a 1031 exchange defers the tax, but it does not eliminate it entirely.

  • To qualify, the real estate must be used for investment or business purposes and must be owned by individuals, C corporations, S corporations, partnerships, limited liability companies, or trusts. The replacement property must be 'like-kind,' meaning it is of the same nature or character as the relinquished property. Examples of qualifying properties include raw land such as timberland, ranch land, and farms, as well as oil and gas royalties, residential, commercial, industrial, or retail property, and mitigation credits for restoring wetlands.

  • One of the primary benefits is that capital gains tax is deferred when you purchase a new like-kind property. The money saved by deferring that tax can then be reinvested into the new property, allowing you to build more wealth. A 1031 exchange also increases your purchasing power, enabling you to diversify your assets across different state lines or market areas.

  • A forward exchange means the seller has sold or relinquished one property before purchasing a replacement. The proceeds from the sale are held in an escrow account by a Qualified Intermediary until the new property is acquired. The buyer then enters a 45-day identification period during which at least three replacement properties must be identified, with the intent to purchase at least one of them.

  • The buyer must close on the replacement property within 180 days, or 135 days after the end of the 45-day identification period. If the buyer fails to meet this deadline, the 1031 exchange is considered void and the taxpayer will owe federal taxes on the sale of the relinquished property.

  • Yes. The staff at AFM Real Estate have worked through many transactions involving 1031 exchanges, assisting both buyers seeking replacement properties and sellers with relinquished property sales. You can contact one of their AFM Real Estate agents to discuss how they can help with your specific land purchase or sale needs.