Like a lot of information in the business world, a Section 1031 Exchange is complex. But it can be made a lot easier to understand and digest when presented in a visual way.
You say you don’t believe it? You say, “I’m from Missouri… show me!”?
Okay, fair enough. Allow me to present a rather complex example: a Section 1031 tax-deferred exchange.
What is a Section 1031 Exchange?
It used to be called a Starker exchange. The term came from the 1979 case Starker v. United States in which an investor challenged an IRS ruling against his non-simultaneous real estate exchange and won. This led to Section 1031 being added to the Internal Revenue Code, which now provides an extensive set of rules for tax-deferred property exchanges.
Section 1031 Exchange Rules Explained Visually
There are a lot of rules and timelines involved in a 1031 exchange. All are important. But rather than give you a long, dry laundry list, here’s an infographic that presents the key points visually.
A Brief History and Explanation of the 1031 Tax-Deferred Exchange
Back in the old days, we called it a Starker. Today, it’s more commonly called a Section 1031 exchange.
But don’t get hung up on the name. Because whatever you call it, it’s a great way for real estate investors to defer taxable gains when selling business or investment property. When properly executed, the seller (taxpayer) can defer all of the gain in his or her transaction by moving it into a newly acquired property.
It’s important to know that this is not a “tax-free” exchange. Your gain still exists. But a 1031 exchange allows you to defer the obligation to pay any tax liability until you sell the new property at some future date. (Or, you may decide to exchange and defer again.)
The beauty of it is that instead of paying taxes with a chunk of your profits, you can leverage all of your proceeds into a larger investment with more income and appreciation potential.
If you’re thinking about entering into a Section 1031 exchange, do your homework. I’ve done a lot of studying on this topic because I have been involved in a few of them myself. It is absolutely crucial that you follow all the rules and meet all the timelines.
The Meaning of “Like-Kind” and How a 1031 Exchange is Accomplished
While it can be used in the exchange of any type of “like-kind” property, the most common application of a 1031 is for business and investment real estate. “Like-kind” is a fairly broad term covering all types of investment property. It doesn’t limit you to exchanging your rental house only for another rental house, for example. You may exchange it for an office building, warehouse, or other investment property.
It also allows transactions to happen non-simultaneously. This means you don’t have to find someone willing to swap properties with you. The 1031 Exchange Rules allow you to sell your property, and then buy any like-kind replacement property you choose, without needing to do a direct trade. The key is that you must use a Qualified Intermediary. This person (or company, also known as an accommodator) acts as a liaison. They collect the proceeds from your sale, hold them in escrow, and then use them to buy the replacement property you designate.
About the 1031 Exchange Infographic
Now, I’m no graphics whiz. This took me about two hours to put together using SmartDraw CI. I could probably have used prettier pictures, but I just used clip art images from the SmartDraw library to keep it simple. If you haven’t tried our infographics feature yet, what’s keeping you? Come on, give it a go!