What is a
1031 Exchange?
A 1031 Exchange (also known as a Like-Kind Exchange) is a strategy that allows real estate investors to defer capital gains taxes on the sale of an investment property, as long as the proceeds are reinvested into another qualifying "like-kind" property. This provision, outlined in Section 1031 of the Internal Revenue Code, can be a powerful tool for preserving equity and growing a real estate portfolio without immediate tax liability.
Capital gains taxes typically apply to the profit from the sale of an investment property, regardless of how long the current owner has held it. However, a properly executed 1031 exchange allows investors to defer that tax by meeting strict IRS requirements around timing, reinvestment, and property type.
The Process
Successfully completing a 1031 exchange requires careful planning and strict adherence to IRS guidelines. The process consists of three key stages:
1. Sale of Relinquished Property
The first step is to sell the existing investment property, known as the "relinquished property." Importantly, the proceeds from the sale must be held by a Qualified Intermediary (QI), not the seller. From the date of sale, the property owner has 45 calendar days to identify potential replacement properties in writing.
2. Identification of Replacement Property
Within 45 days of the sale, the seller must formally identify potential replacement properties to the QI. The IRS imposes rules around this identification process, including limitations on the number and total value of properties identified. The identification must be made in writing, signed by the taxpayer, and delivered to the intermediary by the 45th day.
3. Purchase of Replacement Property
The seller must complete the purchase of one or more of the identified replacement properties within 180 days of the sale of the relinquished property. To fully defer capital gains taxes, the replacement property (or properties) must be of equal or greater value and carry equal or greater debt. Any shortfall may be taxable as "boot."
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