How To Complete a 1031 Tax Deferred Exchange

What is the purpose of a 1031 exchange?

A 1031 exchange is often referred to as a Starker exchange, or simply flipping properties.

Exchanges Allow You to Delay Capital Gains Taxes

Capital gains taxes are deferred if all of the exchange funds are used to purchase like-kind investment property.

The deferment is like getting an interest-free loan on the tax dollars you would have owed for a cash sale. More equity is retained, and that helps you move into properties of higher value each time you perform a 1031 exchange.

What's Eligible?

A 1031 exchange is possible when you sell real estate held for investment purposes. It cannot be used for the sale of your personal residence.

Like Kind Properties

Exchanged properties must be like kind. For a real estate exchange this means real-property for real-property, but not necessarily land for land or a rental house for another rental house. Take a look at the IRS rules for specific information about what types of properties qualify as like kind.

You can exchange a single property for multiple properties, or purchase one property from the proceeds of several. Proceeds not used to purchase new investment property are taxed as a cash sale.

• The Wording is Critical: Your contract to sell or purchase real estate must contain wording that shows an intent to perform a 1031 exchange. A real estate attorney or your qualified intermediary can help you with the wording. You (or your agent) should send the intermediary a copy of the sales contract and any other information they require.

• Identifying the Replacement Property: If you haven't already done so, identify replacement property. You have 45 days from closing on the relinquished real estate, the property you are selling, to identify up to three replacements. Your list must be sent to the intermediary in writing. The IRS offers no flexibility on this time period.

• Closing Dates Are Important: The closing date for the new property must take place within 180 days of the closing on the relinquished property.

• Keep In Touch with All Parties: You or your agent should stay in contact with the intermediary, keeping them advised regarding closing dates. They will be responsible for most of the paperwork associated with the exchange, and may have specific lead-time or other requirements for each step of the process.

• Doing a Partial Exchange: If you plan to use only part of your proceeds for a 1031 exchange, consult with the intermediary to make sure your sales contract is worded correctly. You might also want to talk with an accountant to find out how the cash sale will impact your taxes.

• Compare Intermediaries: Be sure to compare the services, costs, and references of several qualified intermediaries before selecting one to handle your 1031 exchange. The work they do is essential to the success of the exchange--make sure it's a trustworthy and experienced company or individual.

Ask as many questions as necessary to make you feel comfortable with the process. Flipping properties can be lucrative and exciting, but as with selling real estate in other ways, attention must be paid to the details for the process to be successful. A tax deferred exchange is not difficult to do, but there are specific steps you must follow to make sure every aspect of the sale and purchase complies with US tax laws.

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