What is a tax deferred exchange?

A 1031 Exchange is the swap of qualified like-kind real estate for other qualified like-kind real estate structured pursuant to § 1031 of the Internal Revenue Code.

State, federal and depreciation recapture taxes are deferred, and the tax savings are invested in the new property.

Simply put, you increase buying power while deferring taxes.

In the context of real estate, like-kind means real property for real property. Raw land can be exchanged for an apartment complex; a commercial center can be exchanged for a single-family dwelling, etc.

Exchange options

Concurrent or Simultaneous Exchange: The purchase of replacement property closes the day of or the first business day following the close of the sale of relinquished property.

Deferred Exchange: From the close of the relinquished property sale you have 45 days to identify potential replacement properties and 180 days to complete your exchange.

Part Exchange / Part Sale of Personal Residence: You can exchange a percentage of your personal residence if a portion of the property has been held for productive use in a trade or business or as a rental or other commercial use.

Improvement or Build-to-Suit Exchange: Amherst uses exchange funds to take title to replacement property and pay for improvements and/or construction managed by the taxpayer. The improved property is transferred to the taxpayer within the Exchange Period.

Reverse Exchange: Replacement property can be purchased before the relinquished property is sold. There are many creative options to discuss when utilizing a reverse structure. You must have the liquidity to loan an entity the funds required to purchase either the relinquished or the replacement property without benefit of sale proceeds. When a property is uniquely desirable (outstanding price, long sought location, well-suited to your business…) a Reverse Exchange allows you to purchase the replacement property prior to consummating a sale.

Know Your Property to Know An Exchange Is Right For You

Remember that IRC § 1031 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.”

You should know your adjusted basis in the property being sold to be sure that basis is not higher than the selling price. Basis is your initial purchase price + expenditures for property improvements - depreciation taken.

Purchase price + property improvements – depreciation taken = Adjusted Basis

Additionally, if you have other carry-forward losses that could offset all or most of the gain, you would not be able to use those losses if you exchange. “No gain or loss shall be recognized…”

Contact your CPA to confirm your adjusted basis, quantify carry-forward losses if any, and to quantify the approximate tax obligation if you do not exchange. This knowledge will help you make wise decisions about whether a Tax Deferred Exchange is the right tax shelter for you.