It is imperative if you are applying for a 1031 exchange in accordance with the IRS legislation on the matter, that you do not actually receive the funds for any sale that forms the first part of the property exchange. The legislation requires the transaction between the sale of one property and the purchase of another to be highly regulated and if a clear understanding of what is actually required by the IRS is not evident, then you should get in touch with a Qualified Intermediary before making any changes to your current investments. To simply sell one property and then reinvest the money in another property is not enough qualification for deferment of capital gains taxes under Section 1031.

The secret to a 1031 exchange is that the individual concerned does not receive either money or property during the exchange process. If, for example you are paid cash on the sale of a property you have owned, you would not qualify for capital gains tax deferral. It is also important that you understand what a “constructive” receipt means, as this would also make you ineligible for Section 1031 consideration.

Basically you are considered to be in “actual” receipt of the proceeds of a sale of property if you are either given the money, given other property or “have received some other economic benefit” resulting from the sale of a property. You are considered to be in “constructive” receipt of the proceeds from the sale of a property if the money or other economic benefit is credited to your account, available for you to use as a line of credit, or is otherwise available for you to access in some way that provides you with economic benefit. If any of these situations apply, you are ineligible for deferment of capital gains taxes under Section 1031 of the IRS Code.

The safest way to ensure that you are 1031 exchange compliant is to employ the expertise of a Qualified Intermediary individual or company. A Qualified Intermediary becomes part of the real estate exchange process prior to the actual sale of a property; receives the money that is the result of the sale and then holds this money in escrow until a replacement property is found and purchased. It should be noted that there are a number of other rules about 1031 property exchange that pertain to the types of properties eligible under the scheme, the rules regarding “like-kind” properties and the length of time that may occur between the sale of one property and the acquisition of another.
There are a number of benefits to potential investors under the 1031 real estate exchange system, including the ability to realize greater equity in a new or subsequent property investment. This exchange system, that must be adhered to rigorously, can improve the profitability of real estate investments, and therefore should be something that any prospective real estate investor should investigate.

Understanding the 1031 Exchange Definition: What you need to know