1031 Exchanges: What You Need to Know

Typically, when an investment asset is sold, the owner is taxed on capital gains. However, Section 1031 of the Internal Revenue Code provides an exception: If a seller replaces a non-owner-occupied investment property with a like-kind (same or higher value) property, the owner can defer paying taxes on capital gains.

The idea behind a 1031 Exchange (also known as a Starker exchange or a like-kind exchange) is that the taxpayer’s investment is fundamentally the same — only the form has changed — and it would be unfair to tax what is only a gain on paper.

One of the primary benefits of a 1031 Exchange is that an investor is essentially receiving an interest-free loan from the IRS to invest in another property. And this loan amount can be increased through subsequent exchanges.

There’s no limit to the number or the frequency of 1031 Exchanges an investor can conduct. Also, you can sell one property and acquire multiple properties providing the fair market value of the replacement properties does not exceed 200% of the fair market value of the exchanged property.

Investors also have the option of exchanging a property for up to three like-kind replacement properties regardless of fair market value. This is referred to as the “3 property rule.”

A 1031 Exchange can happen simultaneously, but in the vast majority of cases the exchange is delayed. This involves an intermediary who handles the transfer. Under these circumstances, the seller has 45 days to identify a replacement property and 180 days to complete the exchange.