A 1031 exchange allows the seller of real estate to avoid the payment of taxes by acquiring new real estate. As long as the proper procedures are followed, the Internal Revenue Service will recognize the transaction, not as a sale and purchase, but as an exchange of a relinquished property for a replacement property. This recognition as an exchange allows the seller to defer the payment of taxes including capital gains tax, depreciation recapture tax and net investment income tax.
The process for a forward 1031 exchange (reverse exchanges are structured differently) involves seven simple steps:
1. TAX ADVISOR: The exchanger (the individual or business selling property) should consult with a tax advisor to determine the seller's tax liability upon selling. This will determine if an exchange is appropriate.
2. CONTACT GAIN 1031 EXCHANGE: The exchanger contacts Gain 1031 Exchange Company once a closing is scheduled on the relinquished property. Gain 1031 will work with the title company or attorney closing the transaction to prepare exchange documents.
3. CLOSING ON THE RELINQUISHED PROPERTY: At or before closing of the relinquished property, the exchanger, working with the title company closer, will sign the exchange documents and proceeds will be placed in an exchange escrow account set up by Gain 1031. An exchanger must not close on the relinquished property without having an exchange agreement in place.
4. IDENTIFICATION DEADLINE: Within 45 days after the closing of the relinquished property, the exchanger notifies Gain 1031 in writing (forms provided by Gain 1031) of the replacement property(ies) that the exchanger intends to acquire.
5. CONTACT GAIN 1031: The exchanger contacts Gain 1031 when a closing on the replacement property(ies) is scheduled.
6. ACQUISITION DEADLINE: The exchanger closes on the replacement property(ies) within 180 days (or less if the due date of the exchanger's tax return falls within the 180 days unless an extension is filed) from the closing on the relinquished property. Gain 1031 will prepare documents and wire the exchange funds to the title company or attorney closer.
7. ENJOY: The exchanger files their tax return reporting the exchange and enjoys the benefits of tax deferral.