What’s a 1031 Exchange ? Section 1031 of the tax code provides one of the best strategies
for the deferral of capital gain taxes which would ordinarily
arise from the sale of investment property. Exchanging defers
the realization of the capital gain tax, leaving the property
owner with substantially more proceeds to reinvest in a
- Assignment Agreement - A document used to
transfer contractual rights (but not necessarily
obligations) to a third party. Often used to assign the
Purchase/Sales Contract between the exchanger, the Qualified
Intermediary and either the buyer or seller.
- Basis - Method of measuring investment in an
investment property for tax purposes. The following formula
provides an approximate estimate of the adjusted basis:
[Purchase Price + Improvements] - Depreciation Deducted =
- Boot - Fair market value of non-qualified (not
like-kind) property received in an exchange. Examples: cash,
notes [seller financing], furniture, supplies, reduction in
- Capital Gain/Loss - The increase (or decrease) in
the amount received from a sale or exchange over the
adjusted basis of the property.
- Constructive Receipt - A term referring to the
control of proceeds by a taxpayer even though funds may not
directly be in their possession.
- Exchange Agreement - A document used to establish
the contractual relationship between the parties to an
exchange which restricts the Exchanger's access to the
exchange funds and outlines the responsibilities of the
- Exchanger - The party completing the exchange.
The IRS uses the term "taxpayer."
- "Like-kind" Property - Any property used for the
productive use in a trade or business or for investment is
deemed to be like-kind with any other property to be used
for the productive use in a trade or business or for
investment. The way the property is utilized, and not the
type of property, determines if it is like-kind. Like-kind
refers to the nature or character of the property and not
its grade or quality. Examples of like-kind property can
include: single family residential, multi-family
residential, retail, manufacturing, condominiums, offices,
industrial warehouses and bare land. As a general rule, real
property is like-kind as to all other real property except:
(1) An interest in a partnership (2) Primary residences and
vacation and/or second homes (3) Inventory (defined as
property held for sale).
- Qualified Intermediary - An entity who is not an
agent of the taxpayer or a is qualified person and enters
into a written agreement with the taxpayer (the "Exchange
Agreement"). The Exchange Agreement must require that the
Qualified Intermediary acquires the relinquished property
from the taxpayer, transfer the relinquished property,
acquire the replacement property, and transfer the
replacement property to the taxpayer.
- Relinquished Property - The property "sold" by
the exchanger. This is also called the "exchange," "downleg,"
or the "phase I " property.
- Replacement Property - The property acquired by
the exchanger. This is also called the "acquisition," "upleg,"
or "phase II" property.
- "Starker" Type Exchanges - Popular term for the
delayed exchange variation upheld in Starker v. United
States, 602 F.2d 1341 (9th Cir. 1979).
- Section 1031 Tax Deferred Exchange - A deferred
exchange is defined as an exchange in which, pursuant to an
agreement, the taxpayer transfers property held for
productive use in a trade or business or for investment (the
"relinquished property") and subsequently receives property
to be held for productive use in a trade or business or for
investment (the "replacement property").