Save the capital gains with the 1031 Rules IRS

In a 1031 Exchange Rules, an investor acquires a "Replacement Property" without attracting tax on capital gains by selling his property, called "Relinquished Property,".

A middle-man who provides services of paperwork, oversight, escrow, and the whole exchange is overseen by a Qualified Intermediary (QI). Qualified Intermediary is the person ensuring that the transaction conforms to 1031 exchange Rules under Section 1031 of the Internal Revenue Code.

Rule 1: Like-Kind Property

If property differs in grade or quality, both the original and replacement properties must be of "the same nature or character. It is known as Like-Kind property which is a very broad term. Farming equipment for an apartment building cannot be exchanged, because they’re not the same asset. As long as it’s not personal property, you can exchange almost any type of property in terms of real estate.

Rule 2: Investment or Business Property Only

No personal property is covered in a 1031 exchange is only Investment or business property is covered. In short, the taxpayer can’t exchange one primary residence for another.

Rule 3: Greater or Equal Value

IRS needs the net market value and equity of the property acquired must be the same as, or greater than the property sold in order to completely avoid paying any taxes upon the sale of your property. Otherwise, the taxpayer will not be qualified to defer 100% of the tax.

Rule 4: Must Not Receive "Boot"

Taxpayers carry the partial 1031 exchange, under which the new property is of lesser value, but this is not 100% tax-free. In different words, a Taxpayer Must Not Receive "Boot" to completely tax-free the exchange. Any boot earned is taxable to the amount of gain realized on the exchange. This difference is called "Boot," which is the amount the investor has to pay capital gains taxes on. This option is totally okay and generally used when a seller wants to have some cash and is willing to pay some tax.

Rule 5: Same Tax Payer

The name on the tax return and name appearing on the title of the property being sold must be the same with the titleholder that buys the new property. However, every rule comes with an exception. This rule is not put into consideration in case of a single-member limited liability company ("SMLLC"), which is taken as a pass-through to the member.

Rule 6: 45 Day Identification Window

The owner of property has 45 calendar days, after closing of the first property, for the identification of three potential like-kind properties. This is not easy because the deals need to make sense from the money point of view. This is valid, especially in the current market, because individuals tend to increase the price of their properties when there are low-interest rates, therefore finding all the properties you need can be a hurdle.

Rule 7: 180 Day Purchase Window

There is total 180 days time period for the completion of 1031 exchange after the sale of relinquished property. Under which the first 45 days is known as the identification period and remaining days to buy the property and close the deal.

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Beatriz E. Russell is an acclaimed financial writer and blogger with over two decades of experience in writing blogs on finance. he has extensively written on various aspects of blogs on finance.