What is a 1031 exchange?



A 1031 exchange, named after section 1031 of the U.S. Internal Revenue Code, is a way to postpone capital gains tax on the sale of a business or investment property by using the proceeds to buy a similar property. It is also sometimes referred to as a "like-kind" exchange.


What Qualifies as a 1031 exchange?


A key rule about 1031 exchanges is that they’re generally only for business or investment properties. Property for personal use-like your home or a vacation house-typically doesn’t count. Securities and financial instruments, such as stocks, bonds, debt instruments, partnership interests, inventory, and certificates of trust aren’t usually eligible for 1031 exchanges. 


How To Do a 1031 Exchange:


A 1031 exchange can be complex, so you'll likely want to consult with a qualified tax pro or 1031 Intermediary. You can read the rules and details in IRS Publication 544, but here are some basics about how a 1031 exchange works and the steps involved.



Step 1:  Identify the property you want to sell ... 


A 1031 exchange is generally only for business or investment properties. Property for personal use like your primary residence or a vacation home typically doesn’t count.



Step 2:  Identify the property you want to buy ...


The property you’re selling and the property you’re buying has to be "like-kind," which means they’re of the same nature, character, or class, but not necessarily the same quality or grade (more on that below). 


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Step 3:  Choose a qualified intermediary ...


If you don’t receive any proceeds from the sale, there’s no income to tax which is the general idea behind a 1031 exchange. One way to make sure you don't receive cash prematurely is to work with a qualified intermediary, sometimes called an exchange facilitator. Basically, they hold the funds in escrow for you until the exchange is complete (assuming the sale and the purchase don’t take place simultaneously). Choose carefully. If they go bankrupt or flake on you, you could lose money. You could also miss key deadlines and end up paying taxes now rather than later.



Step 4:  Decide how much of the sale proceeds will go toward the new property ...


You don’t have to reinvest all of the sale proceeds in like-kind property. Generally, you can defer capital gains tax only on the portion you reinvest. So if you keep some of the proceeds, you might end up paying some capital gains tax now.



Step 5:  Keep an eye on the calendar ...


For the most part, you have to meet two deadlines or the gain on the sale of your property may be taxable.


      First ... you have 45 days from the date you sell your property to identify potential replacement properties. You have to do that in writing           and share it with the seller or your qualified intermediary.


      Second ... you have to buy the new property no later than 180 days after you sell your old property or after your tax return is due                             (whichever is earlier).



Step 6:  Be careful about where the money is ...


Remember, the whole idea behind a 1031 exchange is that if you didn’t receive any proceeds from the sale, there’s no income to tax. So, taking control of the cash or other proceeds before the exchange is done may disqualify the deal and make your gain immediately taxable.



Step 7:  Tell the IRS about your transaction ...


You’ll likely need to file IRS Form 8824 with your tax return. That form is where you describe the properties, provide a timeline, explain who was involved, and detail the money involved.


Important Things To Know About 1031 Exchanges


Here are some of the notable rules, qualifications, and requirements for like-kind exchanges.







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