What is a 1031 Exchange?

What is a 1031 Exchange?

A 1031 Exchange is a tax-deferral strategy that allows real estate investors to sell a property and reinvest the proceeds into a new, like-kind property while deferring capital gains taxes. This process is named after Section 1031 of the IRS tax code.

🔑 Key Facts About a 1031 Exchange

✔ Tax Deferral: Avoid paying capital gains taxes on profits from the sale of an investment property.

✔ Like-Kind Property: The new property must be similar in nature and used for business or investment (e.g., selling a rental property and buying another rental).

✔ Strict Timelines:

• 45 Days – Identify the replacement property.

• 180 Days – Close on the replacement property after selling the original one.

✔ Must Use a Qualified Intermediary (QI): Funds must be held by a neutral third party (cannot take possession of the cash).

✔ Can Be Used Multiple Times: Investors can continue deferring taxes indefinitely by rolling over investments.

🚀 Example of a 1031 Exchange in Action

🔹 Investor Sells Property: A rental property is sold for $500,000 with a $200,000 capital gain.

🔹 Investor Reinvests: Instead of paying taxes, the investor buys a new property worth $600,000.

🔹 Taxes Deferred: No capital gains tax is due until the investor sells without reinvesting in another 1031 exchange.

📌 Types of 1031 Exchanges

✔ Delayed Exchange – Most common; sell one property, buy another within 180 days.

✔ Simultaneous Exchange – Sell and buy on the same day.

✔ Reverse Exchange – Buy the new property before selling the old one.

✔ Build-to-Suit Exchange – Use exchange funds to improve or build a new property.

⚠️ Important Rules & Restrictions

❌ Primary residences do NOT qualify – Only investment or business properties.

❌ Like-kind doesn’t mean identical – A commercial property can be exchanged for a rental home.

❌ Personal use properties don’t qualify – Vacation homes must meet IRS rental use guidelines.

❌ Boot (Cash-Out) is Taxed – If you take some cash from the sale, you pay capital gains tax on that amount.

Why Use a 1031 Exchange?

✅ Grow real estate portfolio without paying immediate taxes.

✅ Move investments to higher-value properties.

✅ Shift assets to better-performing markets.

✅ Increase cash flow & appreciation potential.