1031 Exchanges

1031 Exchanges | What Investors Need to Know

A 1031 exchange is a tax-deferral strategy used by real estate investors to defer paying capital gains taxes when selling an investment property. By reinvesting the proceeds into another "like-kind" property —meaning any real estate held for business or investment purposes — investors can defer taxes and continue growing their portfolio without an immediate tax burden. The process is regulated by strict timelines and must be facilitated by a qualified intermediary (QI) to ensure compliance with IRS rules. Although taxes are deferred, they are not eliminated, and will eventually be due if the investor sells without reinvesting again. 

Any type of real property qualifies for a 1031 exchange

Properties involved must be held for investment or used in a trade or business. They don’t need to serve the same function — for instance, raw land can be exchanged for an apartment building.

The transaction consists of two steps:

  1. The sale or "transfer" of the relinquished property
  2. The purchase or "acquisition" of the replacement property

To qualify for full tax deferral, the following must be met:

  • The replacement property must be of equal or greater value than the relinquished property.
  • All proceeds from the sale of the relinquished property must be reinvested.
  • Any debt paid off in the sale must be replaced by equal or greater debt on the new property. 

Two crucial deadlines begin from the date the relinquished property is sold:

  • Replacement property(ies) must be identified within 45 days.
  • The exchange must be completed by the earlier of:
    1. 180 days from the sale of the relinquished property, or
    2. The due date of the taxpayer’s federal income tax return, including extensions. 

Replacement properties must be clearly described in writing and signed by the taxpayer. The two most common
identification methods are:

  • 3 Property Rule: You may identify up to three properties, regardless of their value.
  • 200% Rule: You can identify any number of properties, provided their combined value doesn’t exceed 200% of the total value of all relinquished properties. 

The taxpayer must hold title to the replacement property in the same legal manner as they held title to the relinquished property. There are exceptions to this, particularly for certain disregarded entities for tax purposes

We regularly assist real estate investors in navigating the 1031 exchange process. Feel free to reach out with any questions or to discuss your specific needs. We look forward to working together!

1031 Exchanges | FAQs

A 1031 exchange allows real estate investors to defer paying capital gains taxes when selling an investment property by reinvesting the proceeds into another "like-kind" property. This deferral helps investors preserve equity and potentially grow their portfolio.

In a 1031 exchange, "like-kind" refers to any property used for investment or business purposes. The term is broadly defined, meaning you can exchange a variety of property types, such as swapping land for a commercial building or trading an office space for an apartment complex, as long as they are held for investment.

There are two critical deadlines:

  • Identification period: You have 45 days from the sale of the original property to identify potential replacement properties.
  • Exchange period: You must close on the replacement property within 180 days of selling the original property.

A qualified intermediary (QI) is a neutral third party who facilitates the 1031 exchange. The QI holds the proceeds from the sale and manages the paperwork and transactions to ensure compliance with IRS regulations. 

No, 1031 exchanges are only for investment or business properties. Personal properties, such as primary residences, do not qualify for this tax-deferral strategy.

While a 1031 exchange allows you to defer capital gains taxes, it is not tax-free. Taxes will eventually be due when you sell the replacement property without reinvesting in another like-kind property, or when you choose to "cash out."

Yes, you can exchange multiple properties for one or a single property for multiple as long as the properties involved meet the "like-kind" requirement and the overall value is balanced to ensure tax deferral.

Source: New Directions Trust Company

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