1031 Exchange FAQs

1031 is a Section of our Internal Revenue Tax Code (“IRC”).

A 1031 Exchange provides the ability to defer capital gains taxes on the sale of investment property (“relinquished property”) thus providing a path to potential wealth building.

In a 1031 Exchange, the investment property seller (a.k.a. the taxpayer) must meet two requirements for complete tax deferral:

1. Reinvest all net equity from the sale of the relinquished property into investment property (“replacement property”)
2. Acquire replacement property with equal or greater debt that encumbered the relinquished property at sale.

Traditional Investment Property Sale

• Seller/taxpayer lists property 
• Sale proceeds go through Escrow/Attorney
• Escrow/Attorney send proceeds to Seller/Taxpayer
• Taxable event

1031 Exchange

• Seller/taxpayer lists property
• Sale proceeds are routed to a Qualified Intermediary
• Sale proceeds are used to buy replacement property
• Capital Gain Taxes are deferred

Generally, a seller/taxpayer can exchange investment property for another investment property. The replacement property must be “Like-Kind” to the property sold. Whereas all “Real Property” may qualify as replacement property, the term Like-Kind refers to how the replacement property must be used / held for investment purposes. For example, commercial real estate (an investment property) can be exchanged for a single-family vacation rental (investment property). Specifically, the requirements within the tax code state, “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of Like-Kind which is to be held either for productive use in a trade or business or for investment.”

Simply put, disqualified property is property that is NOT an investment property including but not limited to; a primary residence, a second home, flip properties or a property held in inventory for sale. In addition, recent changes to tax law disallow personal property (artwork, boats, etc.) as valid property in a 1031 exchange at the federal level.

Section 1031 of the tax code does not clearly define a minimum amount of time for which taxpayers must hold the investment property. However, when the IRS examines exchange transactions, the taxpayer must be able prove the relinquished property was held for sale and that was their intent. Further, the IRS has indicated that two years of ownership is generally considered to be sufficient evidence of that intent.

The taxpayer selling the relinquished property must be the same taxpayer purchasing the replacement property. If partnership ABC sells the relinquished property, Partnership ABC must acquire the replacement property. If a single woman or individual entity sells the relinquished property, they must acquire the replacement property. Section 1031 Exchanges can accommodate Trusts, LLC’s, Corporations, etc.

For complete tax deferral, the exchanger must reinvest all the net equity received from the sale of their relinquished property and acquire a replacement property with equal or greater debt than what encumbered the relinquished property. An exchange may still be valid if there is a shortfall of reinvestment on the replacement property, however the transaction will likely result in some form of tax liability.

The clock starts ticking the day that the sale of the relinquished property closes. The taxpayer/exchanger has 45 days from the date of closing the relinquished property to identify (ID) replacement property, plus an additional 135 days to close on one or all the properties identified, totaling an entire exchange period of 180 calendar days. However, if your tax filing deadline for the year in which you sell the property occurs before this 180 day deadline, your actual time period may be shorter. Please consult with your tax advisor to discuss potential options available to you.

The identification must unambiguously describe the property (with an address or legal description), and must be made in writing, signed by the taxpayer, and sent before midnight of the 45th day. Replacement property that is acquired (i.e., closes) within the 45-day period is considered the purest form of identification and does not require an ID. There are specific rules and procedures when a 1031 Exchange spans two calendar years. Leader1031’s identification form is incorporated into our Exchange Agreement.

There are three identification rules exchangers use in a 1031 Exchange:

1. Three-Property Rule: The investor may identify up to three properties regardless of value; or
2. 200% Rule: The taxpayer may identify any number of properties so long as the total fair market value of all the identified properties does not exceed 200% of the value of the relinquished property. NOTE: Exceeding 200% of the value will cause a third rule to apply (the “95% Rule”);
3. 95% Rule: If the investor identifies more than three properties, and the combined value of all identified properties exceeds 200% of the value of the relinquished property, the taxpayer must acquire at least 95% of all identified properties or the entire exchange will fail.

A good starting point for moving forward with a 1031 Exchange is to identify a team of trusted professionals including a tax advisor, realtor, and most importantly Qualified Intermediary (“QI”). When selecting a QI it is critical to verify the security of your funds during a 1031 exchange, and the knowledge base and professionalism of your QI who will be interacting with your realtor, tax advisor, escrow, and replacement property representatives. As soon as your relinquished property has gone into contract, you can set up a 1031 Exchange account with Leader1031. This 1031 Exchange account and property legal documentation provided by your QI must be in place prior to close of your relinquished property sale.

PLEASE NOTE: The taxpayer or their tax representative can contact Leader1031 for a free consultation on IRS Code Section 1031 at any time. Contact us to find out how Leader1031 can assist you with your 1031 needs.