1031 Exchange Frequently Asked Questions
Get clear, expert answers to the most common questions about 1031 exchanges, tax deferral strategies, and the exchange process.
Exchange Basics
What is a 1031 exchange?
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows real estate investors to defer capital gains taxes when selling investment property by reinvesting the proceeds into "like-kind" replacement property. This powerful tax strategy preserves your investment capital and accelerates wealth building.
How much can I save with a 1031 exchange?
The tax savings depend on your specific situation, but typically include:
- • Federal capital gains tax: 0%, 15%, or 20% (based on income)
- • State capital gains tax: 0% to 13.3% (varies by state)
- • Net investment income tax: 3.8% for high earners
- • Depreciation recapture: Up to 25%
Combined, you could defer 30-40% or more of your sale proceeds in taxes.
Who can do a 1031 exchange?
Any taxpayer who owns investment or business property can potentially do a 1031 exchange, including:
- • Individual investors
- • Partnerships and LLCs
- • Corporations and S-Corps
- • Trusts and estates
The key requirement is that the property must be held for investment or business use, not as a primary residence.
What is a Qualified Intermediary?
A Qualified Intermediary (QI) is a neutral third party that facilitates the 1031 exchange by holding the sale proceeds and ensuring compliance with IRS regulations. The QI:
- • Prepares all exchange documentation
- • Holds funds in secure, segregated accounts
- • Ensures you never have "constructive receipt" of funds
- • Coordinates with closing agents for both transactions
Using a QI is mandatory - you cannot do a 1031 exchange without one.
Rules & Requirements
What are the 1031 exchange deadlines?
There are two critical deadlines that cannot be extended for any reason:
45-Day Identification Period
You must identify potential replacement properties within 45 calendar days of selling your relinquished property. Identification must be in writing to your QI.
180-Day Exchange Period
You must close on your replacement property within 180 calendar days of selling (or by your tax return due date, whichever is earlier).
What qualifies as "like-kind" property?
For real estate, "like-kind" is broadly defined. You can exchange:
- ✓ Rental house for apartment building
- ✓ Commercial property for raw land
- ✓ Single property for multiple properties
- ✓ Domestic property for domestic property only
The key is that both properties must be held for investment or business use. Personal residences, inventory, and foreign property do not qualify.
What are the identification rules?
You must follow one of three identification rules:
3-Property Rule (Most Common)
Identify up to 3 properties regardless of value. You can close on any or all of them.
200% Rule
Identify unlimited properties as long as their total value doesn't exceed 200% of your sold property's value.
95% Rule
Identify any number of properties of any value, but you must purchase at least 95% of the identified value.
How do I defer ALL taxes?
To defer 100% of your capital gains taxes, you must:
- 1. Purchase replacement property of equal or greater value than your sale price
- 2. Use all net proceeds from the sale (reinvest all equity)
- 3. Obtain equal or greater debt on the replacement property (or add cash)
Any cash or debt relief received (called "boot") will be taxable.
Exchange Process
When should I contact a Qualified Intermediary?
Contact your QI as soon as you have an accepted offer on your property. Exchange documents must be signed before closing. We recommend reaching out even earlier - when you're thinking about selling - to ensure proper planning and maximize tax benefits.
What happens at closing?
At the closing of your relinquished property:
- 1. The closing agent sends proceeds directly to your QI
- 2. Your QI deposits funds in a segregated, secure account
- 3. You receive closing documentation for your records
- 4. Your 45-day identification period begins
Can I access my funds during the exchange?
No. To maintain the tax-deferred status of your exchange, you cannot have access to or control over the exchange funds. Any funds you receive will be considered "boot" and will be taxable. Your QI holds all funds until they're needed for your replacement property purchase.
What if my exchange fails?
If you cannot complete your exchange within 180 days, the exchange fails and:
- • Your QI returns the funds to you
- • You'll owe capital gains taxes on the sale
- • You'll report the sale on your tax return
- • Exchange fees are typically non-refundable
This is why proper planning and working with experienced professionals is crucial.
Additional Questions
Can I do a partial 1031 exchange?
Yes! You can take some cash out and still defer taxes on the portion you reinvest. This is ideal when you need liquidity but want to minimize tax impact. You'll only pay taxes on the "boot" (cash or debt relief) you receive.
What is a reverse exchange?
A reverse exchange allows you to acquire replacement property before selling your relinquished property. This is perfect for hot markets or unique opportunities. We use an Exchange Accommodation Titleholder (EAT) to park either property during the exchange period.
Can I exchange into multiple properties?
Absolutely! You can sell one property and buy multiple replacement properties, or sell multiple properties and buy one. This flexibility allows you to diversify your portfolio or consolidate for easier management.
How are 1031 exchanges reported to the IRS?
You'll report your exchange on IRS Form 8824 with your tax return. Your QI will provide all necessary documentation including:
- • Exchange agreement and amendments
- • Identification notices
- • Closing statements
- • 1099-S forms (if applicable)
Still Have Questions?
Our exchange experts are ready to help you navigate your 1031 exchange with confidence.
Or call us directly at (877) 483-0427