• A Section 1031 exchange is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.
• By deferring the tax, you have more money available to invest in another property. In effect, you receive an interest free loan from the federal government, in the amount you would have paid in taxes.
• Any gain from depreciation recapture is postponed.
• You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.

A 1031 Exchange,also known as a Like Kind Exchange or Starker Tax Deferred Exchange (named for an investor who challenged and won a case against the IRS) is a transaction under United States Law which specifies that if an asset (usually some form of real estate such as land or a building) is sold and the proceeds of the sale are then reinvested in an asset of a similar kind (like kind asset), then no capital gain or loss is recognized, allowing the deferment of capital gains taxes that would otherwise have been due on the first sale. This law is defined under section 1031 of the Internal Revenue Code, 26 U.S.. § 1031.
IRS rules control the length of time that the replacement property must be held before it may either be sold or used to enter into a new tax deferred exchanged. In highly appreciating markets, people may take the opportunity of selling their personal residence (where no capital gain is due below $250,000 for a single person or $500,000 for a married couple) and moving into a former rental property for a specified time period in order to turn it into their new personal residence, and thus avoid capital gains taxes.
In order to qualify for this exchange, certain rules must be followed:

1. Both the relinquished property and the replacement property must be held either for investment or for productive use in a trade or business. A personal residence cannot be exchanged.
2. The asset must be of like kind. Real property must be exchanged for real property, although a broad definition of real estate applies and includes land, commercial property and residential property. Personal property must be exchanged for personal property. (There are some complicated rules surrounding this -- for example, livestock of opposite sex are not considered like kind property for the purpose of a 1031 exchange.)
3. The proceeds of the sale must be invested in a like kind asset within 180 days of the sale. However, the property must be identified within 45 days, but up to three properties may be identified.

Frequently, the most difficult component of a 1031 exchange is identifying a replacement property within the first 45 days following the sale of the relinquished property. The IRS is strict in not allowing extensions.
A 1031 exchange is similar to a traditional IRA or 401K retirement plan. When someone sells assets in tax-deferred retirement plans, the capital gains that would otherwise be taxable are deferred until the holder begins to cash out of the retirement plan. The same principle holds true for tax-deferred exchanges or real estate investments. As long as the money continues to be re-invested in other real estate, the capital gains taxes can be deferred. Unlike the aforementioned retirement accounts, rental income on real estate investments will continue to be taxed as net income is realized.
An alternative to a 1031 exchange for someone who wants to defer capital gains tax, but who does not want to continue to hold property is a structured sale. This method offers both buyer and seller many benefits and is regarded as ideal for those looking to retire from or exit from the real estate or business market.

How a 1031 exchange is accomplished

The following sequence represents the order of steps in a typical 1031 exchange.

1. An investor decides to sell investment property and do a 1031 exchange. He contacts a qualified intermediary (QI) and they enter into an agreement.
2. The investment property is put on the market.
3. An offer to purchase the investment property is accepted and signed by the QI.
4. Escrow for the sale is opened, and a preliminary title report is produced.
5. The QI sends required exchange documents to the escrow closer for signing at property closing.
6. Escrow closes.
7. Within the first 45 days after the close of escrow on the sale of the relinquished property, the investor identifies replacement properties as required by law. This is known as the "Identification Period".
8. Within 180 days after the close of escrow on the sale of the relinquished property, the investor closes on one of the replacement properties which he has identified. This is called the "Exchange Period". This completes the exchange. No cash – or ‘’boot’’, as it is known – is taken by the exchanger.

An alternative to the 1031 exchange

A Structured sale Annuity or "Ensured Installment Sale" is a capital gains tax deferral tool that enables the seller to gain benefits that other sales and capital gains deferral methods do not offer. It is a hybrid of the common installment sale and a structured annuity, and it enables the seller to collect a stream of payments, leverage equity, earn a pre-tax return, and other benefits. This method is a tool for those who want to do a 1031 exchange but cannot find a property within the time frame, and it allows the seller to have a backup plan.

What are the different types of exchanges?

• Simultaneous Exchange: The exchange of the relinquished property for the replacement property occurs at the same time.
• Delayed Exchange: This is the most common type of exchange. A Delayed Exchange occurs when there is a time gap between the transfer of the Relinquished Property and the acquisition of the Replacement Property. A Delayed Exchange is subject to strict time limits, which are set forth in the Treasury Regulations.
• Build-to-Suit (Improvement or Construction) Exchange: This technique allows the taxpayer to build on, or make improvements to, the replacement property, using the exchange proceeds.
• Reverse Exchange: A situation where the replacement property is acquired prior to transferring the relinquished property. The IRS has offered a safe harbor for reverse exchanges, as outlined in Rev. Proc. 2000-37, effective September 15, 2000. These transactions are sometimes referred to as "parking arrangements" and may also be structured in ways which are outside the safe harbor.
• Personal Property Exchange: Exchanges are not limited to real property. Personal property can also be exchanged for other personal property of like-kind or like-class.

When can I take money out of the exchange account?
Once the money is deposited into an exchange account, funds can only be withdrawn in accordance with the Regulations. The taxpayer cannot receive any money until the exchange is complete. If you want to receive a portion of the proceeds in cash, this must be done before the funds are deposited with the Qualified Intermediary.
Can the replacement property eventually be converted to the taxpayer's primary residence or a vacation home?
Yes, but the holding requirements of Section 1031 must be met prior to changing the primary use of the property. The IRS has no specific regulations on holding periods. However, many experts feel that to be on the safe side, the taxpayer should hold the replacement property for a proper use for a period of at least one year.
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