The 1031 Tax Deferred Exchange: What Are the Requirements?

A 1031 tax deferred exchange is an excellent way to preserve equity in your properties. By allowing you to defer income taxes that would usually be charged when you sell a property, you will be in a better position to improve your economic standing. It will also give you added flexibility in managing and expanding your portfolio.

1031 tax deferred exchanges are governed by stringent regulations set forth by the IRS in the Revenue Proclamation 2000-37. Also known as RevProc 2000-37, this document details the requirements necessary to qualify for a 1031 tax deferred exchange. These requirements include:

The types of property that qualify. There is a common misconception that a 1031 tax deferred exchange only applies to real estate. This is not necessarily the case. 1031 tax deferred exchanges apply to other types of property as well. While some property types are explicitly excluded from a 1031 tax deferred exchange, these items are relatively few. Some of the disqualified properties include: stocks, bonds or notes, other securities or certificates of indebtedness, certificates of trust, partnership interests, property being held primarily for resale, and shop inventories.

Intended purpose. Both the property sold and the property to be acquired must be considered of productive use in a trade, a business, or an investment. Properties that are meant to be resold immediately do not qualify. Most primary residences are also disallowed by the IRS from participating in a 1031 tax deferred exchange, since they are not primarily of a trade, business, or investment nature. However, any other houses that you own, provided that they can be used to generate income, may be able to qualify for a 1031 tax deferred exchange.

Like Kind properties. The properties to be exchanged within a 1031 tax deferred exchange must of like-kind nature. For instance, real estate property can only be exchanged for real estate; vehicles can only be exchanged for vehicles, etc. Note that 1031 tax deferred exchanges only apply within the boundaries of the country. Exchanges with foreign properties are disallowed.

A Qualified Intermediary. A qualified intermediary (or QI) is an independent party who facilitates 1031 tax-deferred exchanges. The qualified intermediary cannot be the taxpayer or any disqualified person. It is the QI who acquires the relinquished property and transfers it to the buyer afterwards. The QI is necessary because the IRS does not allow the taxpayer to take direct or indirect control of the money generated from the original sale at any time during the proposed 1031 tax deferred exchange. If the taxpayer or any of his agents take control of the funds at any time during the transaction, the IRS will revoke the exchange. This means that the taxpayer will have to pay the appropriate capital gains tax.

Time Restrictions. There is a 45-day time limit for the identification of replacement properties, and a 180-day time limit for the completion of purchase. If the taxpayer fails to meet these limits, the 1031 tax deferred exchange will fail and the former will have to pay income taxes on the gains of the sale.

Matthew Bass is the publisher of 1031ExchangeAnswers.com He provides more recommendations and information on 1031 Tax Deferred Exchanges that you can research at your leisure on his website.

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