Simone B Knowlton, Red Oak Realty East Bay Real Estate

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What About 1031 Exchange
What you should know about 1031 Exchange


    1031 Exchange allows the deferment of capital gain taxes. It is a means by which investors increase their investment without paying up to 37% in income taxes (combined State and Federal). In 1984 Congress formally approved the delayed or Starker exchange where by an investor can exchange - through the use of a qualified intermediary (like a title company for instance) one investment property against another.

    Actually, the Internal Revenue Code Section 1031 allows the exchange of property other than real estate i.e. such as business assests, paintings. An exchange can be relatively easy for the competent intermediary, it can be thoroughly confusing for the more candid investor rendering the use of an experienced intermediary even more important.

    As for real estate, almost any property that is not a personal residence or second home will qualify under Section 1031. Even a vacation home that is used partly as income producing may be used. (However, this type of "mixed use" property can be exchanges only against other mixed use property). Also, unimproved property (undeveloped lots for example) even if it is of lesser value than the property to be exchanged, can be built upon to exceed the desired value, and can be acquired in an exchange. Two basic rules must be followed:

1. The purchase price of the newly acquired property must be equal to or greater than the net sale of the 'sold' property, and
2. all cash and other proceeds received from the sale of the relinquished property must be used to buy the new property.

    The investor has a total of 180 days from the close of escrow of the 'sold' property to acquire the replacement property. The first 45 days are called 'The Identification Period' and must be used to find and to identify in writing to the intermediary the new property or properties. The investor may identify three properties to eventually acquire at least one. If she or he identifies more than 3, the total fair market value of all identified properties cannot exceed 200% of the value of the relinquished property. This is called the "Two Hundred Percent Rule".

    Any person officially entrusted with the handling of funds for others, is bound by fiduciary responsibilties. However, there are no state or federal regulations governing the conduct of intermediaries. Hence one should choose an intermediary very carefully. Look for experience and reputation in the legal sphere and among title companies. Aim for those who seem especially familiar with the tax code in general. Speak with friends, brokers, lawyers, accountants and with escrow officers who handle exchanges, and ask their opinion.

Some of the reasons investors might want to exchange rather than sell
  • An exchange allows investors to defer capital gains tax
  • Investors may be spending more time than they like maintaining properties. They can exchange several properties for a single one in order to relieve the burden
  • Investors may want to diversify and exchange a property into another city or state
  • An investor may want to exchange out of one property that has a lot of equity for several smaller properties. If at a later date, the investor wants to sell off some of the smaller properties, the tax burden would be significantly less
  • Sellers can take advantage of increased growth and appreciation in a specific area





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Simone B. Knowlton
Phone: (510) 502-1157 | Email: homes@simonebknowlton.com