If you own an investment property and are considering selling it, you may have heard the term “1031 exchange”…But what is it? A 1031 exchange allows you to sell an investment property and defer the payment of capital gains taxes by buying another property that qualifies.
It is named after Section 1031 of the Internal Revenue Code. The concept is easy: rather than sell your property, pocket the cash and pay taxes right away on the gain, you can do a 1031 exchange and move your investment into another qualifying property. However, there are some important rules to keep in mind. After selling your property, you have 45 days to identify potential replacement properties. You then have 180 days from the sale of the original property to complete the purchase of your replacement property.
You also cannot simply receive the sale proceeds yourself and decide later that you want to do a 1031 exchange. A Qualified Intermediary must be involved to hold and transfer the funds as part of the exchange. This is why it is important to start planning your exchange before the sale of your property is completed.
How does the process work?
A 1031 exchange may sound complicated, but the basic idea is simple. When you sell your investment property instead of getting the money from the sale, a Qualified Intermediary holds the money and helps facilitate the exchange.
The first thing you have to do is decide you want to do a 1031 exchange, before you sell your property. The proceeds of the sale will be paid to the Qualified Intermediary, not to you, at the time of the sale. This is important as it might affect your ability to complete the exchange if you are the recipient of the funds.
After the sale, you will have 45 days to identify the replacement property or properties that you want to purchase. There are specific rules about how many properties you can identify and how the identification needs to be made, so it is important to make sure everything is done correctly within the deadline.
Once you identify a replacement property, you will have 180 days from the date you sold your original property. The replacement property must qualify for a 1031 exchange. If you miss deadlines or fail to follow the rules, the exchange may not get the tax treatment you want.
This is a good tool that can give real estate investors an opportunity to keep their money invested in real estate rather than paying taxes immediately after selling a property. Given that the process involves strict deadlines and specific requirements, planning ahead and working with an experienced qualified intermediary can help make the process easier to manage.
Related: see the types of properties we handle, including gas stations, shopping centers, farmland, condos, homes and DSTs.