The 1031 Exchange - What A Deal

A 1031 exchange is a method often used by investors in real estate in order to indefinitely defer capital gains tax liability on a property's sale. This is achieved by relinquishing rights to a property one would like to sell to a qualified intermediary, who holds the funds gained from the sale of the relinquished property and uses the money to buy a replacement property that fulfills the regulations delineated in Section 1031 .

Although the current (and growing) popularity of the 1031 might lead you to believe that it only recently came on the scene, this is not actually true. As a matter of fact, the history of the 1031 stretches all the way back to 1921, though at its conception, it was quite a bit different than what we currently think of as an exchange. Section 1031 really came into its own in the seventies, which saw many important modifications in the way that exchanges were conducted. These modifications paved the way to a farther-reaching conception of the exchange process and created greater interest from investors.

The capital gains tax deferral Section 1031 provides to the investor might, at first glance, appear to be a gift from the US government, but it is, in reality, closer to an interest-free loan. This is because there is an expectation that the taxpayer will repay the extra funds gained from the deferral by accepting capital gains liability upon the eventual sale of a replacement property. Additionally, this interest free loan may be kept for an indefinite period of time; an investor can conduct any number of exchanges before finally electing to sell outright, at which point taxpayer must pay capital gains taxes.

Section 1031 of US tax code represents a mutually beneficial agreement between the investor and the United States government, profitable for the U.S. economy as a whole in addition to the individual investor. By looking upon the transfer of money in an exchange as representing an extension of an existing investment rather than as a discrete transaction liable to be taxed, investors gain the opportunity to move their funds to the most profitable possible investments, which, in turn, boosts the country's economy by bolstering the growth of new jobs.

Like anything else, the 1031 exchange has its skeptics. Some advocates of change in Section 1031 will pose the argument that the tax-free income gained by to the investor in the exchange process lends them an unfair advantage. Another common issue of concern is that the strictness of the time limits attached to steps in the exchange process could engender a frenetic rate of buying, with a resultant increase in asking prices for replacement properties. The aforementioned complaints, however, are only tenuously linked to reality, and the odds that the 1031 exchange procedure will go through any significant change in the coming years are quite low. In general, most will agree that Section 1031 is immensely beneficial to all parties involved, allowing investors increased profits on the sale of their property while also encouraging the creation of jobs and consequently promoting the greater good of the U.S.. Little doubt exists that the 1031 is destined to be a mainstay of the investment world for years to come.