IRS Section 1031 provides an exception and allows the taxpayer to postpone paying tax on the capital gain of a sold property if one reinvests the proceeds into a similar like-kind property as part of a qualifying like-kind exchange. Gains deferred in a like-kind exchange under IRS Section 1031 is tax deferred, but it are not tax free. Whenever one sells a business or investment property and has a gain, one generally pays the tax on the gain at the time of the sale. Notice that a 1031 exchange is a deferment, not a credit or reduction. Although taxes do not have to be paid at the time of the sale, they do have to be paid eventually. It is possible for the final investment to convert into the investor’s primary residence, but they will need to hold the investment for no less than five years, or the sale will be fully taxable. Certain properties, such as securities, stocks, bonds, or notes do not qualify for tax deferred exchange.
Proceeds from the sale must be held in escrow by a third-party intermediary, then used to buy the new property. One may not receive the sale proceeds, even temporarily. There is no limit on how frequently one may do a 1031 exchange. This treatment allows an investment to continue to grow tax deferred. One may roll over the gain from one real estate investment to another and another etc. The taxpayer avoids paying tax until they sell for cash years later, and will pay only one tax at the long-term capital gain rate in effect at thet time of the sale.
In a 1031 exchange, once the sale of property occurs, the intermediary (middleman) must receive the cash from the sale. Within 45 days, one must designate the replacement property in writing to the intermediary, specifying the property one wishes to purchase. Up to three properties can be designated, as long as the taxpayer eventually closes on one of the ones identified. Within 180 days after the sale of the old property, one must close on the new property.
Information is always subject to change on this topic. To learn more visit the IRS site.