1031 Exchange is when “a taxpayer may defer recognition of capital gains and related federal income tax liability on the exchange of certain types of property…” This law can help you defer your taxes if you follow the guidelines really well and apply for a tax deferment on time.
You need to purchase a vehicle, an air conditioner, equipment, computers, etc. for your small business in Los Angeles. After a year, you wish to relocate your business to New York and are now thinking of selling those assets that you don’t wish to relocate with you. The value for your equipment, vehicle, air conditioner, etc. after a year would depreciate. The assets would not be valued at the original cost that you had paid and they would also not be resold at the book value (original cost – depreciation). Buyers would look for fair value or market value for any asset before buying. Sometimes the market value can be lower or higher than the book value. Hence, reselling assets can be a tricky business.
Except for property! Property prices mostly appreciate unless there are very dire consequences such as a recession, crime in a particular area, etc. Now that we have established that investing in property is somewhat awesome, we just have to invest. Buy a piece of land at a certain price and sell at a much higher one the following year. And you are set! Just buy, sell, repeat and EARN!
But this joyride has a speed bump. Capital Gains Tax! So, how to go about deferring your capital gains tax? Simple. Take advantage of the 1031 Exchange!
These are the 4 reasons to take advantage of the 1031 Exchange
1. Tax Deferral
1031 Exchange helps you to defer your taxes. However, this does not mean that you are exempt from paying your tax liability. As long as you sell and buy property in that financial year and file your tax returns according to 1031 Exchange rules, you can keep deferring the taxes for a very long time. In case, that you would like to sell a property and keep the cash, then you would have to pay the tax liability during that financial year. 
2. More Cashflow During the Year
While paying taxes on capital gains, such as a car, bonds, shares, etc. might get you some benefits and the taxes would not be sky-high, imagine the amount of taxes that one would have to pay if they decide to sell a real estate property! This will tip your business scale upside down! Hence, if you sell a property and then purchase another that is like-kind, it would help in deferring your taxes and keeping your cash flow from going off balance during that financial year.
3. Say No to High Maintenance Costs!
Take for example that one or several of your properties are incurring high costs. It could be related to maintenance and more staff being employed to take care of the property, etc. If you swap a high maintenance property for one that yields lower expenses, then you save a tremendous amount of cash flow during the financial year!
4. Let the Government be your Friend and Utilize their Resources!
We have already established that the taxes that you pay during the financial year after selling a property are humongous. That tax payable is resources for the Government. But if you buy a property and defer your taxes, you are indirectly using the Government’s resources to grow your own holdings. The value of your investment properties is bound to increase as real estate mostly appreciates over time. Not only will the value of your investments increase but so will any rental income due to the trading of property for increased value. So what could have been the capital gains taxes for the year is converted into equity that is injected back into your business! 
A Step-by-Step Guide to Benefit from the 1031 Exchange.
3 Broad Rules
- Sell a property. (For Investment purposes.)
- Buy a similarly valued property within 180 calendar days. It needs to be in the same financial year. (For Investment purposes.)
- – File tax returns which let you defer your tax liability!
Title 26 of Section 1031 entails…
“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.“
For 1031 Exchange to come into effect, the properties that you buy or sell need to be used for business or investment purposes. 
- Both the properties need to be of a like-kind, not necessarily identical. “The key issue is that the Exchanger can substantiate that both properties were “held for investment”.” 
- The 45-Day Identification Period. Once a person sells a property, he/she has to identify the next property to purchase within 45 days. This period starts the day you close the sale of your first property on paperwork. Below are two ways in which you can identify the properties:
1). 3 Property Rule
While using this rule, you can list 3 properties without giving regard to their total fair value.
2). 200% Rule
Under this rule, a person can identify an unlimited number of properties as long as the aggregate value of all the properties combined is not more than twice the value of the property sold.
- 180 Calendar days or last day of filing returns – whichever is earliest. Imagine that you have closed the sale of a property on November 30th. The 45 day period of identifying will commence thereafter. Even though a person has a 180 calendar day window, the last day of filing tax returns is on 31st March. Hence, even though a person has 180 days bracket, but to qualify for the 1031 Exchange in their tax returns, they need to close the purchase of their property before 31st March. This gives approximately 120 days to close the deal and file the returns.
So, here we have listed the 4 benefits plus a step-by-step guide on how to take advantage of the 1031 Exchange.
This article is inspired by the works and achievements of Tom Donahue, the CEO of Alumni Alliances, who is also a reputed real estate professional and heads his company True North. You can always get in touch with him via Alumni Alliances to know more about the tips and tricks of commercial real estate.
1. Featured Post – Sabine Peters
2. Internal Revenue Code Section 1031
3. Tierra Mallorca
4. Pros and Cons of a 1031 Tax-Deferred Exchange of Commercial Property
5. The 1031 Exchange for Real Estate Investors
6. The New York Public Library
7. An Introduction to the Benefits of § 1031 Tax Deferred Exchanges
8. An Introduction to the Benefits of § 1031 Tax Deferred Exchanges