In the United States, when you sell an asset for more that what you paid for the asset, the profit is often subject to the payment of capital gains taxes. The rate at which capital gains are taxed fluctuates, but is generally high. As a result, the actual profit realized from the sale of an asset can be significantly reduced. If the transaction qualifies for an Internal Revenue Code Section 1031 Exchange, however, the payment of any required capital gains taxes can be deferred, making a 1031 Exchange an attractive option. There are a number of rules that must be followed in order for a transaction to qualify for a 1031 Exchange deferral, including the use of a 1031 Exchange Qualified Intermediary.
Like-Kind Property
Although there are variations within the concept of a 1031 Exchange, the basic concept anticipates an “exchange” of like-kind property. The definition of “like-kind” can get complicated, but imagine a simple example. If you purchased an investment property five years ago for $75,000 and you now wish to sell it for its current market value of $125,000, the $50,000 difference would be subject to capital gains taxes. If, however, you purchased another “like-kind”, such as another similar investment property, within the allowable 180 days following the sale, you may be able to defer the capital gains taxes. In addition, you must identify the exchange property within 45 days after the original sale.
Qualified Intermediary
In order to facilitate the “exchange”, and comply with the rules, you must use a 1031 Exchange Qualified Intermediary. The Qualified Intermediary takes possession of the relinquished property and transfers it to the new buyer as well as takes possession of the replacement property and transfers it to the original seller. All funds used in the transaction must also pass through the Qualified Intermediary. The IRS regulations regarding who can act as a Qualified Intermediary are very specific. As a rule, a Qualified Intermediary is a company or business that has no personal relationship with the participants of the 1031 Exchange transaction and has no stake in the transaction itself other than as the role of intermediary. The relationship between the buyer, seller and Qualified Intermediary is typically explained in depth in a contract entered into between the parties in order to ensure that all parties understand how the process must work in order for the benefits of a 1031 Exchange to be realized.
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