How To Follow Replacement Property Rules and Regulations

Section 1031 of the IRS code defines the rules and regulations pertaining to replacement property. Replacement property exchange is a convenient way to defer taxes on capital gains when you sell any property. In order to gain the benefits of tax deferral, one is required to buy another similar or ‘like’ property within a prescribed period of time from the date of sale. For those who are interested in replacement property rules and regulations, here’s a brief rundown on Section 1031 requirements…

1.    There are no limits on the number of buying and selling transactions you can make on replacement property during your lifetime.
2.    The buying or selling of replacement property should not be for earning profits. If profits are the goal, then the tax benefits are not applicable.
3.    Tax deferrals are available only if you buy and sell ‘like’ or similar property, i.e. you cannot sell a building and buy a vacant plot of land. Both the bought and sold properties must have similar values, though you can buy more than one ‘like’ property with the sale proceeds, provided the total value of the bought properties equals the amount earned by the sale. For example, if you sell a property valued at $10,000, then you can choose between buying a single replacement property of the same value or buying three different properties, whose combined price equals $10,000.
4.    For the replacement property exchange to be valid, the transactions must be carried out through an independent, neutral and qualified third party, who does not have any present or previous association with either of the parties involved in the transaction. This third party is responsible for handling all stages of the transaction, including all documentation, preparing the necessary tax paperwork and holding the money while the transaction is underway.
5.    Section 1031 also lists certain types of properties which cannot be used for replacement property transactions. These are:
a.    Full or part-time residential properties for a period of one year from the date of buying such property;
b.    Properties that are located outside US territories;
c.    Properties bought with the express purpose of refurbishment or renovation and later sold for a profit;
d.    Investments made in the stock market;
e.    Interests in a trust, partnership or other entities where the seller is a trustee or beneficiary.
6.    All replacement property transactions are time-bound as follows: (i) Like or similar property must be identified within a period of 45 days; and, (ii) the sell and buy transactions must be completed in 180 days before or after the due date for filing tax returns for that year. To clarify, if the filing of returns for that financial year is 1st April, then the replacement property exchange must have been completed 180 days before this date, or must be undertaken 180 days after the 1st of April. Effectively, the total time period within which the replacement property exchange must be concluded is 45+180 or 225 days.
7.    Any amount received in excess of the like property value bought, will be liable for capital gains tax.

These are the basic requirements which are to be met in case of replacement property exchanges. You can consult a tax or legal professional for more in-depth information on replacement property rules and regulations.