Delaying Capital Gains Tax

Tax Deferred Real Estate Exchanges


Section 1031 of the Internal Revenue Code allows an owner of investment real estate to defer the recognition of taxable gain from the sale of property by exchanging the property for other investment real estate.


If a 1031 tax deferred exchange is completed, it is possible that the taxes which are being deferred today may never have to be paid. This is possible because when your heirs inherit your investment property at your death, they take the property with a basis which has been stepped up to its current fair market value. Any subsequent gain is limited to the gains from the heirs date of acquisition, not from your years of ownership.


A 1031 exchange can either be a simultaneous exchange or a delayed exchange. In a simultaneous exchange, your existing property is exchanged for new property at the same time in an interdependent closing. In a delayed exchange, your existing property is exchanged for a promise from someone, usually a “qualified intermediary”, to acquire new property for you at a later date. A qualified intermediary is an independent third party in an exchange transaction.


Property that is exchanged in a 1031 exchange must be “like-kind” property. The IRS has defined the words “like-kind” to refer to the nature and character of the item of property and not its grade or quality. Different types of real estate are deemed to be included within the same class and can be given 1031 exchange treatment when exchanged.


There may be tax consequences in a 1031 exchange if (1) the Replacement Property is not equal to or greater in value than the Relinquished Property; (2) you do not use all of the exchange proceeds to purchase the Replacement Property; or (3) the Replacement Property does not have debt equal to or greater than the Relinquished Property.


It is recommended that you seek tax advice when doing a 1031 tax deferred exchange in order to ensure that you comply with all the requirements.

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