1031 Exchange

A 1031 Exchange, or tax-deferred exchange, is a method that allows the owner of real property to sell one property and to acquire another “like-kind” property within a specific time frame. A 1031 Exchange is unique because the entire transaction is treated as an “exchange” and not just as a simple sale. It is the difference between “exchanging” and not buying and selling which allows the taxpayer to qualify for deferred capital gain treatment, basically transferring the gains from the “relinquished property” to the “exchange property.”

The basic concept that allows a 1031 Exchange to defer capital gains is when the seller of the property does not take “constructive receipt” of the funds in any way. The seller of the property will avoid “constructive receipt” of the sale proceeds through the use of a 1031 Exchange Escrow administered by a Qualified Intermediary, or QI. The QI is an independent party who facilitates tax-deferred exchanges according to Section 1031 of the Internal Revenue Code. The QI cannot be the taxpayer or a disqualified person. The QI, acting under a written agreement with the taxpayer, acquires the relinquished property from the seller and transfers it to the buyer. The QI then holds the proceeds from the sale of the relinquished property, to prevent the taxpayer from having “constructive receipt” of the funds. Finally, the QI acquires the replacement property and transfers it to the taxpayer to complete the exchange within the appropriate time limits, allowing the taxpayer to defer capital gains tax.