Corporate Law Blog

1031 exchange: a business strategy to defer capital gains tax

For businesses, it is important to be aware of strategies that can help decrease tax liability. In this post, we want to talk about one such strategy: 1031 exchanges, also called like-kind exchanges. This tax strategy essentially involves the exchange of a business or investment asset—usually, but not necessarily, real estate—for another. Corporate stock and partnership interests are not eligible for 1031 exchanges.

For businesses, the idea behind a 1031 exchange is to avoid capital gains tax involved when a business asset is sold. Businesses are able to swap one asset, often real estate, for another indefinitely, deferring capital gains tax each time until the property is eventually sold for cash. When the property is eventually taxed, it is then only taxed once.

One important point about 1031 exchanges is that it is possible—even common—to do a delayed exchange in which a third party holds the cash proceeds from the “sale” of the property and who then uses that cash to “purchase” the replacement property. The replacement property must be designated in writing within 45 days.

It is possible to designate multiple properties—at least three, but potentially more if the business meets certain conditions—as long as the business closes on at least one of them within six months. Delaying an exchange is a valid approach which allows businesses that are not able to immediately find a property that works for a direct swap to take advantage of a 1031 exchange.

In our next post, we’ll continue discussing this topic. 

Sources:

IRS, “Like-Kind Exchanges under IRC Code Section 1031,” Feb. 2008.

Forbes, “Ten Things to Know About 1031 Exchanges,” Robert Wood, Jan. 26, 2010.