Also known as a "like kind exchange", is a transaction which specifies that if an asset (usually some form of real estate such as land or a building) is sold and the profits of the sale are then reinvested in a like kind asset, then no gain or loss is recognized, allowing the deferment of capital gains taxes that would otherwise have been due on the first sale. This law is defined by section 1031 of the Internal Revenue Code.
It is important to clarify that the IRS section 1031 is not applicable to sale of securities and shares in corporations, partnership, limited liability companies and real estate investment trusts REITs.
In order to qualify for this exchange, certain rules must be followed:
The investment property that you are going to sell must be hold for a minimum period of one year and one day. The property can't be on sale in the MLS before this period or the property will nor qualify.
45 days rule & Identification rule (calendar days). After the closing (sale) of your qualified investment property you have 45 days to identify and list the replacement properties. You can identify up to 3 different properties or you have to comply with the 200% rule. When more than 3 properties are identified the IRS rule limits the combined purchase price to 200% the sale price of the property object to the exchange. There is no extension to the 45 days, if you don't comply, you can't do the exchange.
180 days rule (calendar days). The IRS 1031 Exchange rule requires the purchase of the replacement property before 180 days from the 45 days rule.
Qualified intermediary. The IRS rule establishes that you use a qualified intermediary to make the legal documents and hold the money from the sale of the first property. The IRS doesn't establish who will be the intermediary, however defines who can't be. In general, the intermediary has to be someone totally independent and that you don't know for the previous two years of the exchange.
Title holding. The fist property and the replacement property must held title in the same ownership.
Reinvest all the money. In order to defer all the capital gains, you must reinvest all the money. That means that if you use any cash, that gain will be taxable.