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What Is a Section 1031 Exchange?

In the normal course of things, a taxpayer is required to pay capital gains taxes any time a gain is realized on the sale of a capital asset. Although just about any asset qualifies as a capital asset, a common example of when capital gains taxes are incurred is when a taxpayer sells real property. Understandably, taxpayers are always looking for ways to limit, or avoid altogether, capital gains taxes. One option that may work to defer capital gains tax when the asset in question is real property is to enter into a Section 1031 Exchange in lieu of a traditional sale. So, what is a section 1031 Exchange? Knowing the answer to that question may come in handy and could save you a significant amount in taxes someday.

Internal Revenue Service (IRS) Code Section 1031, from whence the name came, allows a taxpayer to enter into an exchange of property instead of a traditional sale if certain pre-requisites and requirements are met. In addition, a Section 1031 must follow specific procedures in order to qualify for deferred tax treatment.

For a transaction to qualify as a Section 1031 Exchange, the following must all be true:

  • The property must be held for productive use in a trade or business, or for investment. As a general rule, this means that your primary residence will not qualify for a Section 1031 Exchange. However, under specific circumstances, a primary residence may
  • The property must be exchanged for “like-kind” property. A single family home cannot be exchanged for gold, for instance.
  • The entire exchange must be completed within 180 days. A Section 1031 Exchange is not completed in a single transaction as is a traditional sale. There are steps that must be taken to complete a 1031 Exchange. All of those steps must be completed within 180 days.
  • A Qualified Intermediary, or QI, must be used to facilitate the exchange. A Qualified Intermediary is someone who has been trained and certified to act as the required intermediary during a Section 1031 Exchange. The QI will take possession of funds and titles and hold on to them until it is time to release them to a party.

If a transaction does qualify as a Section 1031 Exchange, it means that the capital gains taxes that would normally be due on the realized gain will, instead, be deferred until such time as the property is actually sold.

Entering into a Section 1031 Exchange can be a wise decision that can have beneficial tax consequences, yet the rules for a Section 1031 Exchange are complicated. If you are considering a 1031 Exchange, you need to get in touch with an experienced Pennsylvania real estate law attorney as soon as possible to discuss your options. Contact the real estate law attorneys at Curley & Rothman, LLC by calling 610-834-8819 today to schedule your free consultation and learn more about how we can help you.