"What Exactly is a 1031 Exchange?"

Without a doubt, the most commonly asked question is "What exactly is a 1031 Exchange?"

The 1031 Exchange, named after the IRS code allows the exchange, can allow you to sell business or invest real estate and replace it with other business or investment real estate without creating a taxable event.

Many investors don't realize that on sale of investment property does not have the same exclusion enjoyed when you sell your principal residence. If you sell the property for more than you paid for it, you usually have a taxable gain. With a 1031 Exchange, you can defer the payment of the tax normally due on sale.

There are many benefits to performing an exchange instead of a sale and purchase of another property. A 1031 Exchange can be a great way to have more funds available for the new purchase. Since a 1031 Exchange defers any tax payment, that money will now be available for the new property.

A 1031 Exchange can also help you with cash flow by allowing you to sell investment properties that aren't giving you as mush return as you'd like and use the non-taxed gain to purchase one that produces cash flow. You can even trade out large property for several smaller ones or several small properties for one large.

To qualify for a 1031 Exchange, you must trade real estate that you hold for business or investment purpose for other business or investment real estate. For example, land can be traded for an apartment or vice-versa. 1031 Exchange cannot be used in that involved a personal residence.

Here are a few things to keep in mind if you are planning a 1031 Exchange:

1. Both the old and new property must be either land or rental property (including business property).

2. You have 45 days from the closing date of your first property to identify three properties you may purchase in exchange.

3. From the date of closing of the first property, you have 180 days to close on any of the three properties you identified in the first 45 days.

4. The proceeds must go to a Qualified Intermediary, who in turn buys the next property from your list of three. If you take proceeds from the first sale, each dollar taken may be subject to capital gain tax. To avoid the tax, you must rollover the entire gain into the new property.

5. You are not required to exchange all of your cash from the sale of the first property into the purchase of the second. However, taking cash from the sale can create a taxable event for you.

This can get very confusing. We'd love the opportunity to show you how it may work for you.

Disclaimer: As with any tax issue, be sure to consult an accountant or tax professional for specific information.