Articles

Tax Free Exchanges

(IRC §1031)

by James M. Carney

A tax free exchange allows a real estate owner to transition from one parcel of real estate to a parcel of equal or greater value and defer income taxes as long as certain requirements are met. This type of transaction is referred to as a "like kind exchange" or a "1031 exchange" which refers to the Internal Revenue Code Section outlining the requirements for such a transfer. Exchanges are not necessarily complicated but there are certain rules that have to be followed in order to qualify.

Originally, exchanges required the actual transfer of one piece of property for another. Regulations have since been enacted which allow for a "deferred" exchange which is currently the most popular method of completing such exchanges. A deferred exchange allows a property owner to sell a parcel of real estate and then, within certain time restraints, find another parcel of real estate and use the proceeds from the sale of the first parcel of real estate to buy the second parcel. The funds cannot be received by the owner but need to be deposited with a "qualified intermediary" until replacement property can be found. Again, there are certain requirements for designating the replacement property and completing the transfer.

Any cash or other "like kind" property received by a seller is considered "boot" and taxable to the extent of the total gain.

In order for the exchange to be valid the property must be "like kind" property however it does not have to be identical property. For example, farm ground can be exchanged for residential real estate and residential real estate can be exchanged for commercial real estate. The like kind exchange is satisfied because each item is "real estate". In addition, assuming you can find a fast builder, you can sell property and build a new property to replace it if it can be done within 180 days of the closing of the original sale.

The important thing to keep in mind is that the IRS has established rules that must be followed to qualify an exchange for tax free treatment and you need to consult your tax advisor and attorney to make sure those rules are followed.