Lober Dobson & Desai LLC
Attorneys at Law
Atlanta | Macon
In the world of business, Internal Revenue Code Section 1031 exchanges are a common
tool used to defer capital gains taxes, dispose of investment property and use equity
from one investment property to acquire replacement investment property. §1031
does not eliminate taxes, but rather defers them to a later time. This section of the
Tax Code is highly regulated and therefore comes with a number of conditions that must
be fulfilled in order for the IRS to accept the exchange. There are also a number of
non-tax reasons that individuals choose to do §1031 exchanges including: to exchange
a number of small properties for a larger one, to ease management responsibilities, to
exchange for property that may be easier to sell in the coming years and exchange for
property that the taxpayer can use in his or her own profession.
There are two types of property in §1031 exchanges: 1) the relinquished property
- the property that is to be sold by the taxpayer and 2) the replacement property - the
property that will be purchased by the taxpayer to replace the sold property. To qualify
for a tax-deferred §1031 exchange, both the relinquished and replacement properties
must be held by the taxpayer for investment purposes. Any attempt by the taxpayer to
hold the property for personal use will prevent the property from qualifying for the
In addition, the relinquished property must be exchanged for replacement
property that is “like-kind.” Like-kind property refers to the nature or
character of the property. For the most part, all real property is “like-kind” with
all other real property. Some general examples of like-kind exchanges include, bare land
can be exchanged for rental property; single family rental property for multi-family
rental property; and a rental vacation home for a medical office in which the taxpayer
intends to practice. Finally, all the proceeds from the relinquished property must be
used to purchase the replacement property. If the taxpayer receives cash or other benefits
from the transaction in hand, capital gains tax must be paid on that amount.
There are two important deadlines that the taxpayer has to adhere to
in order to take advantage of the §1031 exchange:
(1) Identification Period: the taxpayer must identify the replacement
property to be acquired by the end of the exchange period within 45 days of the transfer
of the first relinquished property.
(2) Exchange Period: the taxpayer must receive the replacement property
within the earlier of (a) 180 days of the transfer of the relinquished property or (b)
the due date, including extensions, for the taxpayer’s tax return for the tax year
in which the transfer of the first relinquished property occurs.
As a taxpayer interested in a §1031 exchange, you should consult with your accountant,
attorney and qualified intermediary. The qualified intermediary should be identified
early in the sale process so that the transactions can be conducted in a timely manner.
The accountant and attorney can advise you further regarding the tax effects and legal
ramifications of your §1031 exchange, while the qualified intermediary will be the
person or entity that holds the proceeds from the sale in a separate exchange account
until the funds are used to purchase the replacement property.