How to Do a Tax-Deferred Exchange on Investment Property

Ordinarily, when you sell property for a profit and receive cash, the taxman is there to take his cut. A 1031 tax-deferred exchange on investment property allows you to roll over the gain from the sale of one investment property into another investment property without being taxed. (Note that this opportunity is available only on investment and income property - not on a personal residence.)

Instructions

Difficulty: Moderately challenging

Things You’ll Need:

• Calculators
• 1031-exchange Facilitators
• Real Estate Attorneys
• Personal Financial Software

1. First, understand three basic rules: 1) The purchase price of the replacement property must be equal to or greater than the net sale price of the property you're relinquishing; 2)All cash or other proceeds received from the sale of the relinquished property must be used to acquire the replacement property; and 3) The properties must be of "like-kind," which means they must be the same type of property - must be, for example, property held for productive use in a trade or business or property held for investment.
2. Select an exchange facilitator to handle paperwork and to receive the funds from the proceeds of the sale.
3. Sell your investment property to a buyer; you must inform the buyer that you are doing a tax-deferred exchange.
4. Identify a replacement property within 45 days of the close of escrow or the date you transfer title of the investment property you relinquished. The address of the new property must be written down, signed by you and received by the intermediary or exchange facilitator within this 45-day period. (Failure to meet the identification requirements will make the sale of the relinquished property a taxable event.)
5. Acquire the identified replacement property within 180 days of the close of escrow or transfer of title of the investment property you relinquished. When you purchase this replacement property, you must make the seller aware that you are doing a tax-deferred exchange.

Tips & Warnings

• When you are looking for a property to acquire, you may identify up to three properties of any value; one or more of these must be acquired.
• One property may be exchanged for several, or several properties may be exchanged for one.
• Unimproved real property held for investment qualifies for this type of exchange.
• It's important to carefully plan the exchange with the assistance of an experienced and competent intermediary, preferably one who is completely familiar with the tax code in general as well as Section 1031.
• You, as the investor, may never receive or have access to proceeds from the sale of the relinquished property.