What is a 1031 Exchange?

Simply stated, it is a way for owners of investment real estate to buy and sell property and defer payment of any capital gains taxes by reinvesting their money in other “like kind” property.  These transactions are known as deferred exchanges or 1031 Exchanges.  “Like kind” is a bit of a misnomer in that it can really be any type of real estate held for business or investment purposes; so, for example, an apartment building could be exchanged for vacation villa or a beachfront lot.  The key is that these code provisions relate to the sale and purchase of properties held primarily for business or investment.

Section 1.1031 of the IRS Code lays out in detail the procedure for turning a sale and purchase transaction into a qualified 1031 exchange thereby deferring your capital gains tax obligations. The good news is that the provisions of this IRS code apply to the U. S. Virgin Islands.

Essential Elements of a 1031 Exchange

One of the rules is that you are not allowed to receive or touch any of the money from the sale of your relinquished property.  Instead, the rules require that a “safe harbor” or Qualified Intermediary receive, hold and safeguard the proceeds of the sale until the exchange is completed.  There are bonded companies that specialize in accommodating 1031 Exchanges.

The rules also require that certain time limits must be adhered to.  You can identify up to three possible “replacement” properties in which to invest, but must do so within 45 days of the close of escrow on the first property.   The ultimate acquisition of the replacement property must be completed within 180 days.

To defer all tax obligations, you must reinvest 100% of the sale proceeds (including any amounts used to pay off existing loans) into a “like kind” property or properties of equal or greater value than the property you sold.

The above outlines only the most basic elements of an exchange.  While the rules in practice are quite simple to follow, you need expert advice to insure that you are following all of the rules and therefore benefiting from the 1031 tax savings provisions.  Get the advice of your attorney or tax consultant in selecting a Qualified Intermediary.  Their fees vary and their methods for holding the exchange proceeds differ.  It is also important to know if the Qualified Intermediary will be investing the funds and in what type of investments.