What You Should Know about Real Estate Exchanges for the Real Estate License Exam

The Real Estate License Exam may ask you a couple of questions about exchanges. You don’t always have to pay cash for a piece of investment property. You can trade, just like you did with baseball cards (well, not quite). Under certain circumstances, the government allows you to exchange one piece of property for another.

These exchanges are known as 1031 exchanges, after the section of the law that governs them, or tax deferred exchanges, because one of the advantages is the deferral of capital gains tax. You don’t have to get too technical in terms of what to remember about exchanges, but here are a few facts and terms you need to remember for the exam.

  • Like kind: To qualify for an exchange, the two properties must be of like kind according to IRS definitions, and they must be investment properties.

  • Time limits: Some exchanges have time limits during which they must be completed.

  • Boot: If properties are exchanged and they don’t have equal value, even if one of the properties has increased in value, capital gains tax is deferred, but it eventually must be paid when the property is sold. If the properties are not equal in value, cash or personal property sometimes is included in the deal. This cash is called boot. The person receiving it owes taxes on the boot.

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