1031 exchanges offer tax savings when selling and buying investment properties. It encourages reinvestment in the real estate market by deferring capital gains taxes on the sale of one property when the funds are put directly towards the purchase of another property. If you are both selling and buying an investment property, consider using a 1031 exchange to defer capital gains taxes.
1031 Exchange Program Requirements
There are several key requirements for using the 1031 exchange program.
Both Properties Must be for Investment
Both Properties Must Be Like-Kind
Only Applies to “real estate”
Funds Must Be Given to a Qualified Intermediary (QI)
Replacement Properties must be identified within 45 days.
Closings must occur within 180 days.
Let’s take a closer look at each of these requirements.
1 – Investment Properties
The 1031 exchange program cannot be used for primary residences. The program only applies to investment properties. This does not exclude property types, such as single families. You could certainly have a single family that is used for investment (i.e. rental income).
2 – Like-Kind Properties
The property being sold and the one being purchased must be like-kind. In other words, they must be a similar type of investment. For example, if you are selling a 2-family property to buy another 2-family, those are clearly like-kind. There is some gray area in interpretation of like-kind. Consult with an attorney experienced in 1031 Exchanges if you have questions on two specific investments.
3 – Real Estate Only
Unfortunately, the 1031 Exchange program is for real estate only. You cannot use it for other types of properties such as motor vehicles and antiques. For assets, such as parking spaces, fall into a gray area of the real estate definition. Again, speak with an attorney regarding whether it qualifies.
4 – Use a Qualified Intermediary
For a valid 1031 exchange, money from the sale of a property cannot be within your control. They must go directly to a Qualified Intermediary. If you accidentally receive funds from the sale of an investment property, that immediately disqualifies you from using the program.
5 and 6 – Deadlines
After you close on the sale of your first investment property, that date is used for two very important deadlines. You have 45 days to provide a list of properties that you might purchase and 180 days to actually purchase one of those properties. Missing either deadline or buying a property not on the list will disqualify you from using the program.
Summary of Using a 1031 Exchange to Defer Capital Gains Taxes
The thing to remember about 1031 exchanges is that you must intend to use an exchange from the start. This way, you can arrange for funds from the sale of your property to be sent to the Qualified Intermediary. You will also coordinate with that QI to declare properties that you may purchase and to have the funds transferred for your ultimate purchase of a replacement property. If you follow the process and rules precisely, you will benefit from saving significant money on capital gains taxes.
This is a very basic overview on using a 1031 Exchange to defer capital gains taxes. Please consult with an attorney and tax professional for more detailed guidelines and for assistance with completing an exchange.