What tax is deferred in a Section 1031 Exchange?
Capital gains tax has two (2) components: the tax due on the profit earned on the sale of the investment or income property AND the tax due on the recapture of deprecation previously taken by the taxpayer during the time the taxpayer owned the property.
Under Section 1031, the Internal Revenue Code defines that "no gain or loss shall be recognized on the sale of property held for productive use in a trade or business or for investment purposes, if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or investment."
What are the requirements for a valid exchange?
Both the relinquished property and the replacement property must be held for productive use in a trade or business or for investment.
Excluded from Section 1031 Exchange: property for sale; inventories; stocks, bonds, or notes; other securities or evidences of indebt ness; interest in a partnership; certificate trusts or beneficial interest. In general, if property is not specifically disqualified, it can be included for tax-deferred treatment.
You cannot change into or out of personal residence. If your vacation homes are not rented out, then it may not qualify for 1031 Exchange.
Replacement property acquired must be like kind to the property being relinquished.
The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property.
The investor must meet these value requirements:
1. You as Taxpayer must reinvest all your net equity proceeds into the replacement property.
2. Purchase replacement property(ies) that is equal or greater than the net sales price of the relinquished property.
3. Obtain equal or greater debt on the replacement property. Additional cash from the Exchanger can offset the debt, however, increasing the debt cannot offset a reduction in cash equity.
Most deferred exchanges are facilitated by Qualified Intermediaries who will assist you in meeting the requirements of Section 1031.
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How does 1031 Exchange work?
A Qualified Intermediary (QI), like Easy 1031 Exchange of California, facilitates the transaction of a 1031 exchange.
1. You, as the Seller, will arrange for the sale of the property and you will include exchange intentions in the contract.
2. At closing, sales proceeds go to Qualified Intermediary (QI) for a 1031 Exchange.
3. You identify potential exchange properties within 45 days of the closing.
4. You complete 1031 exchange within 180 days of closing.
These steps can occur simultaneously. We suggest, but not require, that before you sell your property, you consider what type of replacement property will work best for you, and whether or not you want to own a whole or partial interest in a property.
Under Section 1031, the Internal Revenue Code defines that "no gain or loss shall be recognized on the sale of property held for productive use in a trade or business or for investment purposes, if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or investment."
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What are the advantages of 1031 Exchange?
You can accomplish virtually any objective with 1031 Exchange, including greater control of your investment, various options for investing (diversification), improved cash flow, geographic relocation and/or property consolidation. You have the opportunity to increase your overall net worth by continuously compounding tax deferred dollars and leverage into higher valued property or properties. It is a powerful real estate investment-planning tool that allows you as investor to achieve investment goals.
Two major reasons to invest are financial leverage and strategic flexibility. In financial leverage, you receive an increase in available capital when the tax liability in a transaction is deferred. This capital can be used to acquire the replacement property. You gain financial leverage through an exponential increase in cash and appreciation - which results to your increase of buying power.
On the other hand, you can employ a number of tactics to increase strategic investment flexibility, by:
- Relocating your investment property closer to where you reside.
- Changing property types.
- Diversifying one into many for ease of future investments. This is when you exchange one larger property and opt to exchange it for multiple smaller properties in different geographic locations. It can be the other way around. You exchange multiple properties and consolidate into one larger property.
- Improving investment performance.
- Replacing older properties with newer ones.
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Aero 1031 Exchange of California 
