A 1031 Exchange, also known as a Like Kind Exchange or Starker Tax Deferred Exchange (named for an investor who challenged and won a case against the IRS) is a transaction under United States law which specifies under section 1031 of the Internal Revenue Code, 26 U.S.C. § 1031the following:
“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”
I have had a number of clients involved in 1031 Exchanges and there is often confusion on what they are and how to execute them correctly. Here’s a quick summary.
In essence, a 1031 Exchange (otherwise known as a tax-deferred exchange) is the strategy of selling one investment property (that’s qualified) and acquiring another investment property (also qualified) within a specific time frame. Any property owner or investor should consider such an exchange when he or she expects to acquire a “like kind” property after the sale of an existing investment property. A 1031 exchange is unique because the entire transaction is treated as an exchange and not as a simple sale, which, in the end, allows the taxpayer to qualify for a deferred gain treatment with the IRS in lieu of a capital gains tax. The main rationale for a 1031 is that the IRS depreciates capital real estate investments every year as long as you hold the investment, until it is fully depreciated. Whenever you sell the property, the IRS will tax you on the depreciated value.
Anyone thinking about executing a 1031 Exchange needs to make sure they choose an experienced real estate agent, a Qualified Intermediary and a professional Escrow company to insure that the property qualifies and that all documents are prepared properly. There are definite tax benefits to a 1031 but even minor mistakes can lead to major financial loss. It’s critical to find a professional Exchange Accommodator before embarking on this investment strategy.
Exchanging Fractional Ownership Interests Under Section 1031
Fractional ownership, also known as interval ownership, is becoming an increasingly popular form of property ownership in Hawaii where resort living is in high demand and the cost of property continues to rise.
Fractional ownership is an arrangement in which two to six individuals or entities hold shared legal title to a single parcel of real estate or a condominium unit. Each owner owns a fraction of the total ownership. This arrangement allows those who might not otherwise be able to afford the resort lifestyle to do so by sharing the expense of ownership with others.