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Recent tax changes, including cuts in the capital gain tax rates have not dampened the popularity of tax deferred exchanges of real estate and other business assets under Section 1031 of the Internal Revenue Code.

A tax deferred exchange is simply a method by which a property owner, trades one property for another without having to pay any federal income tax (and perhaps state income tax) on the transaction. The tax is deferred until some time in the future, usually when the newly acquired property is sold.

In the exchange, the property owner disposes of one property and acquires another property, however there are important guidelines which must be followed in order for the transaction to meet the conditions of Section 1031.

Important guidelines are:

1. The exchange must be for like-kind property, in other words property also for use in business or investment, however it need not be for an identical use.

2. The fair market value of the replacement property must be equal to or greater than the fair market value of the property being sold.

3. All of the exchange proceeds from the sale must be used to acquire the replacement property. None of the proceeds may be used. The IRS regulations require that the funds be held by a “qualified intermediary.” The funds may not be left in an account to which the seller has any access.

4. The amount of debt (mortgage) undertaken in the purchase of the replacement property must be equal to or greater than the debt (mortgage) paid on the property being sold.

5. The titleholder of the property being sold must be the purchaser of the replacement property.

6. The replacement property must be identified within 45 calendar days from the sale of the original property.

7. The purchase of the replacement property must be completed within 180 calendar days from the sale of the original property.

There are many companies, including some title companies, acting as Section 1031 exchange intermediaries. Theses companies will hold the funds in escrow and prepare the Exchange Agreements to be executed at the time of the original sale. 

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