A 1031 exchange is a regulated strategy under the IRS tax code that allows businesses to defer paying taxes on investment property by exchanging one like-kind property for another. Traditionally, a 1031 exchange is designed to occur instantaneously. However, because the probability of such simplicity is low, there are four different types of exchanges that covers a multitude of possibilities and scenarios. Knowing available options of 1031 exchanges prepares a business for a maximum increase in capital gains with minimal taxes.
A simultaneous 1031 exchange occurs when the initial property is swapped for the replacement property and both transactions are finalized on the same day. A delay in the operation deems the exchange ineligible and results in the application of full capital gains taxes. A simultaneous exchange can be performed solely by the two parties involved, in which case the deeds and ownership of the property are immediately interchanged. Alternatively, a qualified intermediary may facilitate the entire exchange in a simultaneous manner.
The delayed exchange is the most common form of 1031 exchanges. A delayed 1031 exchange occurs when the business or investor relinquishes the initial property before identifying and acquiring the replacement property. The investor must market and sell the relinquished property before initiating the delayed exchange. From this day, the investor has a 45-day window to identify a replacement property, a part of the regulation that retains its own options and parameters. The closing of the new property must then be finalized within 180 days of the sale of the original property. During this timeframe, a qualified intermediary holds the proceeds of the initial sale and does not transfer the funds to the investor until completing the acquisition.
Similar to a delayed exchange, a reverse 1031 exchange occurs when the replacement property is acquired before the relinquished property is identified or sold. Under an Exchange Agreement, an intermediary typically takes and holds the title of the replacement property until a buyer for the initial property is found. The business or investor has 45 days from the acquisition to identify the property that will be sold and 180 days to finalize the transaction to qualify for a reverse 1031 exchange. Subsequently, the intermediary releases the title and ownership of the replacement property to the investor and closes out the exchange.
An improvement exchange, otherwise known as a construction exchange, allows the business or investor to make improvements on the replacement property prior to the official acquisition. To qualify for total tax deferral, the IRS code does not allow the investor to make improvements after securing ownership. Thus, an intermediary must hold the title until the improvements are complete. The other stipulations are similar to those of a delayed exchange, which allows 45 days to identify and 180 days to finalize. Typical examples include constructing a building on a vacant lot or making other property enhancements to add value and limit boot.
Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!