In the United States, Section 1031 of the Internal Revenue Code governs the sale and purchase of similar capital assets and is known as a like-kind exchange. Under a Section 1031 transaction, there are two assets: the prior capital asset that is being sold and the new capital asset that is being purchased. Stringent time deadlines govern the timing of these transactions.
General
A like-kind exchange under Section 1031 of the Internal Revenue Code allows a taxpayer to defer the payment of capital gains tax on appreciated property or other capital assets. By purchasing a second property of similar nature or character, the taxpayer may transfer the basis, or adjusted cost, of the first asset to the second. Through this transfer, recognition of capital gain or loss on the sale of the first asset is deferred until the second asset is itself sold. Section 1031 exchanges are most commonly performed for the sale of real estate property.
Identification
The Internal Revenue Service (IRS) enforces several stringent deadlines governing the timing of Section 1031 exchanges. The first is the identification of the second asset. The IRS requires that the second asset, the asset to be acquired, be identified within a 45-day period from the sale of the first asset. As a result, while there are no specific timing guidelines on the sale of the first asset -- it can be sold anytime after the asset is acquired -- in practice, most sellers will have already identified a second acquisition asset prior to the sale of the first asset.
Acquisition
The second timing characteristic is that the second asset must be purchased within 180 days of the sale of the first asset. For real estate transactions, the Section 1031 asset most commonly exchanged, this means that all due diligence proceedings, such as title searches and physical inspections, must be completed before the end of the 180-day time frame. Because real estate transactions are often delayed, most sellers will have already advanced negotiations into a final stage and performed most due diligence proceedings prior to the sale of the first asset.
Resale
The IRS does not restrict the subsequent sale of the acquired assets. Capital assets acquired pursuant to a Section 1031 exchange may generally be sold at any time subsequent to the completion of the exchange. From a practical standpoint, taxpayers attempt to hold on to Section 1031 property as long as possible, since Section 1031 property typically involves a large deferred capital gain that the seller must recognize, and pay taxes upon, when the acquired assets are sold.
