Using a 1031 Exchange to Finance Investing

Posted on June 14, 2010 by IC N in Residential
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Section 1031 allows taxes to be deferred when property used in a business or trade or for investment purposes are exchanged for property of the same kind within 180 days. The replacement property must have been identified in writing within 45 days of the sale of the first property. An exchange agent must be used whenever the exchange is not simultaneous to avoid the taxpayer ever handling the funds.

Property used as a primary residence or a secondary home that has not been rented out for the purpose of profit is not eligible. Mere appreciation of an asset is not sufficient to call the property an exchangeable investment—there must be a business purpose such as use primarily as an office building or as a rental.

If extra cash is added in order to complete the exchange then that extra cash, called the “boot,” is not deferred and gain on that portion must be recognized upon sale. The “boot” may include cash received back at closing, cash paid for service costs that were not part of the closing costs, borrowing that was done in excess of what was needed to purchase the replacement property, or any personal property that is not like-kind received at the exchange.

Don’t exchange out of class– real property for personal property–however you can exchange vacant land for one with a house built on it, if the intent for both is a business purpose or money-making investment. One could sell a couple rental homes on a 1031 exchange in order to purchase an interest in an apartment building, within the specified time limits. Judicious use of the 1031 exchange to buy and sell property to be held for investment purposes is a great way to keep more of the profit.