A 1031 tax deferred property exchange is an exchange in which capital gains tax deferral is available to real estate owners who sell their investment, rental, business or vacation real estate, and reinvest the net proceeds in other real estate. Real Estate held for these purposes are called like-kind/1031 properties.
Property owners may sell like-kind properties and defer taxes on the sale's profits by meeting the requirements of Internal Revenue Code (IRC) 1031 exchange. The purpose of the 1031 Exchange is to allow sellers of like-kind property to buy replacement property of like-kind within a specific time period and defer taxes.
Sellers have a maximum of 180 calendar days from the closing of the initial sale to complete the exchange. Within the first 45 days of this period a seller must designate candidate properties and properly identify them to the IRS. A seller may target up to three properties regardless of value or a group of properties with a combined value that does not exceed 200 percent of the value of the initial property sale. The funds in a trust account can be used as earnest money for designated property once all IRS requirements for a 1031 transaction are met.
If no new properties are identified in the first 45 days or no designated transaction is completed during the full 180 day period, the trust will be liquidated and the sale proceeds will be taxed at the prevailing capital gains rate.