A 1031 tax deferred exchange refers to Internal Revenue Code 1031, which allows real estate investors to defer payment of capital gains on real estate investment sales if they reinvest in a like-kind property.

The following criteria must be met in order for a real estate investor to qualify for a 1031 exchange. As in all financial and legal matters, one should consult with competent legal and/or tax advisors.

• An exchanger has 180 days to complete their exchange after the transfer of the relinquished property, or the due date of their tax return for the year in which they relinquish their property (unless an extension is filed), whichever occurs first.
• By the 45th day, replacement property must be identified in a manner consistent with the IRS regulations.
• The IRS sets forth three options for exchangers when identifying replacement properties:
  1. The investor may identify three properties of any value, one or more of which must be acquired within the 180-day acquisition period. This is referred to as the Three Property Rule.
  2. Unlike the Three Property Rule, the 200% of Fair Market Value Rule allows the investor to identify more than three potential replacement properties as long as the total fair market value of all the potential replacement properties identified does not exceed 200% of the sales price of the relinquished property (or properties).
  3. The 95% Exception Rule: If the investor identifies replacement properties that exceed the Three Property Rule and the 200% of Fair Market Value Rule, the identification will still be considered for a 1031 exchange if the investor acquires at least 95% of the value of properties that were identified.
     

A word of caution: if the investor does not acquire at least 95% of the value of the properties identified, the entire gain may be subject to tax.

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