Section 1031 of the Internal Revenue Code gives us a terrific tool for deferring capital gains tax. We can defer paying capital gains tax upon the sale of real estate and personal property held for business use or investment if we use the proceeds of the sale to purchase “replacement property,” and if certain rules are followed closely.

The benefits of Section 1031 are not available, however, to those who purchase homes with the intent of quickly fixing them up and selling them at a profit. In those cases, the homes are considered to be held for sale and not for business or investment.

Among the rules that must be followed under Section 1031 are strict time limits. Within 45 days after closing on the sale of property (called the “relinquished” property), the seller must identify, in writing, “replacement” property that will be purchased with the proceeds from the sale of the relinquished property. The seller must then purchase the replacement property within 180 days after selling the relinquished property.

If the seller needs to purchase the replacement property before selling the relinquished property, the transaction can still qualify for tax deferral under what is called a “reverse exchange.” It is also possible to do a “simultaneous” exchange in which both the sale and the purchase take place at the same time.

In all types of exchanges, the transaction must be conducted through a “qualified intermediary” who will provide specialized paperwork and handling of funds throughout the transaction. The qualified intermediary’s services are in addition to the services provided by realtors and attorneys.

Please contact us for more information about tax-deferred exchanges under Section 1031, or for referral to a competent qualified intermediary.