What is a 1031 Exchange?
A properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property, and to defer capital gains taxes. IRC section 1031 (a)(1) states:
“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”
1031 Exchanges & Tax Savings
1031 tax deferred exchanges allow real estate investors to defer capital gains taxes on the sale of a property held for productive use in trade, business, or for investment. This tax savings provides many benefits including the obvious – 100% preservation of equity. Investors can take advantage of exchanges to meet other objectives including:
Exchanging from a high equity position, or free and clear property, into a much larger property with some financing in order to increase their return on investment.
Such as exchanging into other geographical regions or diversifying by property type such as exchanging from several residential units into a retail strip center.
For example, exchanging out of multiple relinquished properties into either a replacement property like an apartment complex with an on-site manager or a tenant-in-common ownership program.
1031 Exchange Rules
Although an exchanger can identify more than one replacement property, the maximum number of properties that can be identified is limited to one of the following three rules:
The 3 Property Rule
Three replacement properties without regard to their fair market value.
The 200 Rule
The value does not exceed 200 percent of the aggregate fair value of all relinquished properties.
The 95% Rule
Any number of replacement properties without regard to the combined fair market value, as long as the properties acquired amount to at least 95 percent of the fair market value of all identified properties.