Like-Kind Exchanges: The Basics of 1031
A 1031 exchange or “Like-Kind” exchange, is where you sell an investment property or business and reinvest the proceeds from the sale in a property or properties of a like-kind of equal or greater value. Utilizing 1031 allows you to avoid paying capital gains taxes at that moment.
Steps involved in a typical 1031 Exchange
(1) Choose a qualified intermediary that will coordinate the exchange
(2) Sell your current real estate property
(3) Identify potential replacement properties within a 45-day window
(4) Close on the replacement property within 180-days of sale of the previous property
(5) File IRS Form 8824
Qualified Intermediaries are necessary when doing a 1031 exchange because traditionally, any proceeds that are received from a sale are taxable. A qualified intermediary relieves you of this burden because the proceeds from the sale are transferred to them, rather than to the person making the sale. A qualified intermediary will then hold the funds involved in 1031 until the proceeds can be transferred to the replacement property seller.
Sale of Current Property
Once you have identified a qualified intermediary, you can now sell your property. At this point, the clock begins ticking on the entirety of the exchange.
Identify Potential Replacement Properties
This is where the “Like-Kind” comes into play. The IRS defines like-kind as, “of the same nature or character, even if they differ in grade or quality.” This means that both the sold property and the replacement property must be used for the same purpose. In other words, almost any investment or business property could be considered “like-kind” under the definition provided by the IRS.
The second part of this, and arguably the most important aspect is the strict 45-day window. Once you identify potential properties, the identification must be in writing, signed, and delivered to a party of the exchange i.e., the seller of the replacement property or the qualified intermediary.
Close on Replacement Property
That ticking clock from the sale of current property ends here. You have 180-days from the date of sale to close on the replacement property. The funds from the sale of your previous investment property will be used for this and your qualified intermediary will be the one to transfer those funds.
IRS Form 8824
This is the form that you will use to report the “like-kind” exchange that was just completed.
*Disclaimer – The information provided above is for general informational purposes only.
The professionals at the Center for Financial, Legal, and Tax Planning, Inc., are here to answer any questions you may have in regards to a 1031 “like-kind” exchange. For more information, please reach out to us at (618) 997-3436.