For real estate developers and investors, capital gains can be bitter-sweet. It’s great to make a profit, but nobody likes writing a check to Uncle Sam.
A 1031 exchange (“1031” refers to the applicable section of the internal revenue code) allows real estate investors and real estate developers to defer capital gains by “exchanging” property for the same type of property (e.g. – selling real estate and using the proceeds to buy more real estate). At its core, a 1031 exchange simply occurs when you either 1) make a simultaneous trade for like-kind property, or 2) sell property and use the proceeds to purchase more property. 1031 exchanges are also referred to as “like-kind exchanges.”
What’s the catch? There are a litany of IRS statutes, regulations, and rules to follow. For instance, unless you can make a simultaneous trade, you will likely need to use a qualified intermediary. A qualified intermediary holds the proceeds from the sale of property (referred to as “relinquished property”) until you select new property to buy (referred to as “replacement property”). A qualified intermediary is necessary because you are not allowed to be in receipt of the proceeds from the sale of relinquished property, you are only allowed to receive the replacement property.
There are countless other rules that may apply to any particular 1031 exchange. For instance, if you a dealing with a related party (e.g. – a family member) or if you are selling property in certain states with laws related to qualified intermediaries (e.g. – Colorado), special caution must be taken.