What Is a Tax-Deferred 1031 Exchange?

By R.W. Bowlin  

The 1031 exchange is one of the most effective ways for investors to maximize their investment real estate strategy. 1031 exchanges can be applied in numerous ways to facilitate portfolio growth, cash flow, diversification or many other objectives investors pursue. Unfortunately, 1031 exchanges feel opaque, complex and daunting to many investors, therefore this important planning tool is often overlooked by property owners. 

1031 Overview

A properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes. IRC Section 1031 (a)(1) states: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, 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 for investment.” Investors often ask themselves, why would the IRS include such an effective tool for wealth creation in the revenue code? We will unpack the history of the code as well as where it stands within the current tax reform debate.

Exchange Implementation and Execution

Maximizing an exchange requires forethought, planning and time. There are several considerations to take into account in order to achieve the most value out of an exchange. Furthermore, executing a compliant exchange means sticking to a rigid timeline, both before and after the sale of the property to be exchanged. We will discuss the issues, strategies and pitfalls that rise from the exchange implementation and execution.

Exchange Variations and Applications

The beauty of a 1031 exchange lies not only in the tax treatment, but the breadth of options available for the proceeds of the exchange. Investors often assume they are limited to exchanging one-for-one into another direct ownership property, but that is far from the truth. Here we will present a myriad of options one may apply exchange proceeds toward, including pros and cons of each so you, the investor, can determine how they best fit in your real estate strategy.

1031 exchanges present a tremendous opportunity for real estate investors, especially those owners looking to transition from active to passive ownership as they move through the third and fourth quarters of life. Our firm, Real Estate Transition Services, looks forward to sharing with the investor and advisory communities our knowledge acquired through advising on and executing numerous exchanges. 

**This article was published in the January 2017 - RHAWA "Current" the monthly publication of the Washington Rental Housing Association.