What Is a 1031 Exchange?

A 1031 exchange (also called a like-kind exchange or Starker exchange) is a tax-deferred strategy under IRS Section 1031 that allows real estate investors to defer capital gains taxes when selling an investment property by reinvesting the proceeds into another like-kind property.

How Does a 1031 Exchange Work?

A 1031 exchange helps investors defer capital gains taxes by following specific IRS rules, including reinvesting in like-kind properties and meeting strict deadlines.

1031 exchange types

1031 Exchange Rules & Requirements

To qualify for a 1031 tax-deferred exchange, investors must follow these key rules:

  • Like-Kind Property Requirement

    – The new property must be similar in nature to the one sold. For example, a rental home can be exchanged for a commercial building.

  • Investment or Business Use

    – Both properties must be held for investment or business purposes. Personal residences do not qualify.

  • Use a Qualified Intermediary (QI)

    – The sale proceeds must go through a qualified intermediary, not directly to the investor.

  • Equal or Greater Value

    – To defer all taxes, the new property must be of equal or greater value, and all proceeds must be reinvested.
Real estate investor strategy
1031 Exchange Deadlines

1031 Exchange Deadlines

Strict IRS 1031 exchange time limits apply:

  • 45-Day Identification Period

    – Investors must identify potential replacement properties within 45 days of selling the original property.

  • 180-Day Purchase Deadline

    – The new property must be purchased within 180 days of the sale.
Boot in a 1031 exchange

Types of 1031 Exchanges

Investors can choose from different 1031 exchange structures based on their needs:

  • Delayed 1031 Exchange

    – The most common type, where the new property is purchased after selling the original one.

  • Simultaneous 1031 Exchange

    – The old and new properties are exchanged at the same time.

  • Reverse 1031 Exchange

    – The replacement property is purchased before selling the original one.

  • 1031 Improvement Exchange

    – Investors use funds from the exchange to improve the replacement property.
Like-kind property rule

Risks & Limitations of a 1031 Exchange

While a 1031 exchange provides tax benefits, there are risks to consider:

  • Depreciation Recapture

    – If the investor later sells without another exchange, they may owe taxes on prior depreciation.

  • Boot (Taxable Gains)

    – If cash or non-like-kind property is received in the exchange, it may be taxable.

  • Strict IRS Rules

    – Failure to follow deadlines or requirements can disqualify the exchange.
Example of a 1031 Exchange

Example of a 1031 Exchange

An investor sells a rental property for $500,000, with a capital gain of $200,000. Instead of paying taxes on the gain, they reinvest all proceeds into a new $600,000 rental property. This defers capital gains taxes, allowing them to grow their real estate portfolio tax-efficiently.

Should You Use a 1031 Exchange?

A 1031 exchange is a powerful tax strategy for real estate investors, but it requires careful planning. Always consult a tax professional or qualified intermediary before proceeding.

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Should You Use a 1031 Exchange?