For those who do not understand what a 1031 exchange is, but you have heard of it and would like to know what it is now is your chance. Also, I will do my best to explain it in very simple terms so that no matter your background you will be able to understand it and how you can benefit from it.
First, to understand what a 1031 exchange is, you should understand the purpose behind it. The whole concept behind a 1031 exchange is to defer some taxes (capital gains tax) from the sale of that property, when you plan to invest the profits from that sale directly into another property. People do this so that they do not lose any equity in the transition from one property to another.
So now that you understand the purpose, you should understand a little bit about how it works. First, you are required by law to have what is called a QI. This is a 3rd party that is independent and serves as a Qualified Intermediary (hence QI). They are there to hold the profits from the sale of the first property that you sale until you invest it into another property(s).
Next, there are some rules about what can and cannot qualify for a 1031 exchange. First, remember that we are discussing property. This cannot be done with anything but investment properties. However, that can be widely defined to mean single family rental units, multi-family rental units, office buildings, storage facilities, raw land, retail shopping centers, and industrial facilities.
Second, the move from one property to another has to be of like kind. This does not refer to the condition or value of the properties, but rather that they are similar in character or nature. They (referring to all properties involved) must also be held for productive use in trade or business or held for investment purposes.
There are a lot of other specific rules that the IRS has for this kind of exchange and that is likely why they require anyone who does this to use a qualified professional trained in this.
1- The value of the new property must be of equal or greater value than the one you are selling.
2- The equity of the new property must also be of equal or greater value than the one you are selling.
3- The debt on the new property must be equal or greater to the debt on the property that you are selling.
4- ALL of the net profits from the property that you are selling must be used to acquire the new property.
There are also some strict timeline guides related to 1031 exchanges. First, the investor must identify the new property within 45 calendar days of the close of the old property. (There are some guidelines about how you identify, but that is a later discussion) Second, the investor must close on the new property within 180 calendar days from the closing date on the old property. I hope that this has helped you understand, in plain English, what a 1031 exchange is. There is a lot more information out there on it and you should consult a professional if/when you get serious about doing this.