A 1031 Exchange is part of the IRS tax code, Treasury Regulation 1.1031(k)-1(g). For our purposes, it allows real estate investors to sell their investment property and invest the sales proceeds into a replacement investment property (or properties) without having to pay taxes on any long-term capital gains recognized through the sale of their original property.
Steps Involved in a 1031 Exchange:
- Hire a Qualified Intermediary.
- Sell original investment property (closing date establishes the Exchange Date).
- Identify possible replacement properties within 45 days of the Exchange Date.
- Close on replacement property within 180 days of the Exchange Date.
Specific Requirements for a 1031 Exchange:
- The property that is being sold must have been an investment property (for at least one year plus a day to qualify as a long-term investment; 2 years is often recommended), and the replacement property(ies) must also be used as an investment. It does not matter what either property was/is used for before the exchangor bought it, or after he/she sells it, only what it is used for while it is owned by the exchangor.
- The exchangor must hire a Qualified Intermediary to handle money from the sale of the property. The exchangor is not allowed to have direct control over the sale proceeds.
- The exchangor must identify possible replacement properties within 45 days of the exchange date (the date when the sale on the original investment property closes). The exchangor has 3 choices:
- identify 3 properties without regard to their individual, or total fair market value.
- identify more than 3 possible properties, identifying the fair market value of each, while making sure that their combined fair market value is not greater than 200% of the FMV of the original property.
- exchangor can identify more than 3 properties with a total value of more than 200% of FMV, but must acquire 95% of the value of the properties that are identified.
- The exchangor must close on the replacement property within 180 days of the exchange date. The exception to the 180 days is if the “exchange date” is late in the calendar year, and the due date (including extensions) of the tax return that would cover this transaction comes before the 180 days is up – the exchangor would be then required to close prior to the tax due date.
- To be completely tax deferred, all proceeds from the sold property must be used to purchase the replacement property, therefore the replacement property(ies) will be of equal or greater value than the original property.
- The exchangor must take title of the replacement property in the same name that he/she owned the property that is being “exchanged”.
- The 1031 Exchange transaction cannot take place between “related persons” – specifically meaning your spouse, brother/sister, parent, grandparent, child, or grandchild. It also refers to any business in which you own more than 50% (includes your spouse’s ownership). There are exceptions for a “direct swap” or cash sale.
* Discuss your 1031 Exchange plans with your CPA or tax attorney to maximize benefits.
Contact us to sell your existing investment property, find replacement properties, learn more about the 1031 process, or to for help in connecting with a Qualified Intermediary.