Let’s face it, nobody likes paying taxes. If you’re planning on selling an investment or business property and purchasing another, you might, however, like to hear this: There’s actually an Internal Revenue Code (IRC) that could allow you to postpone and maybe even reduce the taxes you have to pay on capital gains. To shed some light on this heavy topic, we spoke with Tom Savino, CPA of Bonanno, Savino, Davies & Ganley P.C., in Framingham.

Tom, why would someone want to take advantage of Section 1031?

Tom: You may plan on selling your property to purchase a different kind of property to diversify your investment portfolio or expand your business. Or to invest in a property that offers higher return potential.

But if you sold your property in a traditional way, it could trigger a profit known as depreciation recapture, which is taxed as ordinary income. Also, the value of the property may have greatly appreciated impacting your cost basis and raising your tax burden. A 1031 exchange can help you defer those gains, giving you more capital to invest in the replacement property. Keep in mind that it doesn’t mean you won’t have to pay taxes. When the replacement property is sold (if it’s not part of another exchange), the original deferred gain, plus any additional gains realized since its purchase, are subject to tax.

What exactly is Section 1031?

Tom: It’s a section of the Internal Revenue Code that allows individuals, corporations, trusts, and other tax-paying entities to reinvest the proceeds made on selling investment. They accomplish that by purchasing a similar property, within a certain timeframe, in a qualifying like-kind exchange.

How does a deferred exchange work?

Tom: Again, you could sell your property and then use the proceeds to purchase another. But doing so would trigger a taxable event: paying capital gains on the proceeds from the sale. With a deferred-exchange, the money you receive for your property is provided to an exchange facilitator, which is a qualified intermediary between you and other sellers. The facilitator will hold the funds until they are transferred to the seller of the replacement property. Since the proceeds are placed with the exchange facilitator and not with you, selling the property won’t trigger a taxable event.

What is an exchange facilitator?

Tom: It’s basically a qualified intermediary who helps with the transfer of funds and properties. The exchange facilitator cannot be your real estate agent, investment banker, attorney, tax preparer, or anyone who has worked for you in those capacities.

Where can you find an exchange facilitator?

Tom: You should be very careful in selecting a facilitator as there have been incidents of some declaring bankruptcy and being unable to meet their contractual obligations.  I would recommend asking for a referral from someone you trust, such as your CPA or attorney.

What are the restrictions?

With a 1031 exchange, both the real estate properties you sell and buy must be in a trade or business, or for investment. While personal property like your home or vacation home are not qualified for 1031 exchanges other tax code exclusions may apply to reduce the taxable gain.

In addition, there are two very important time limits involving exchanges. First, you have 45 days from the day you sell your property to identify replacement properties. And second, the replacement property must be received and the exchange must be completed no later than 180 days from the sale of your property.

Where can you go to learn more about 1031 exchanges?

Tom: I would recommend talking to your tax representative to learn more about how a 1031 exchange could benefit you.