1031 Exchange: 101

Use 1031s to Defer Capital Gains and Build Wealth

Key Points

• A 1031 exchange is a tax break that allows you to swap a property held for business or investment purposes with a new one, deferring capital gains tax on the sale.
• Properties exchanged must be considered like-kind by the IRS to defer capital gains taxes.
• Proceeds from the sale must be held in escrow by a third party and used to purchase the new property, without any temporary access to the funds.
• 1031 exchanges can be beneficial for estate planning, as heirs are not required to pay deferred taxes.

A 1031 exchange involves swapping one real estate investment property for another, allowing deferral of capital gains taxes. Like-kind exchanges are surprisingly flexible.

Rules and Timelines

45-Day Rule: Designate the replacement property in writing to the intermediary within 45 days of the sale.

180-Day Rule: Close on the new property within 180 days of the sale of the old property.

WARNING: The 45-day and 180-day periods run concurrently. If you designate a replacement property exactly 45 days later, you’ll have just 135 days left to close on it.

If there is cash left after acquiring the replacement property, the intermediary pays it at the end of 180 days. This cash, known as boot, is taxed as partial sales proceeds.

Failing to consider loans can lead to unexpected tax liabilities. For example, a mortgage difference between the old and new properties may result in taxable gain.

Estate Planning Benefits

Tax liabilities cease upon death, relieving heirs of paying deferred taxes. They inherit the property at its stepped-up market-rate value, making 1031 exchanges advantageous for estate planning.

Ready to leverage a 1031 exchange for your next real estate investment? Contact our expert team to navigate the complexities and maximize your investment potential