1031 Exchange
A 1031 exchange is a tax-deferred transaction under IRC Section 1031 that allows real estate investors to sell an investment property and reinvest the proceeds in a "like-kind" property while deferring capital gains taxes, provided strict IRS deadlines are met.
Exam Tip
1031 = tax DEFERRED, not eliminated. 45 days to identify, 180 days to close. Must use Qualified Intermediary. Like-kind = real estate for real estate. Same taxpayer rule.
What is a 1031 Exchange?
A 1031 exchange (also called a like-kind exchange or Starker exchange) is a powerful tax strategy authorized by Section 1031 of the Internal Revenue Code. It allows real estate investors to defer capital gains taxes when selling investment property, provided they reinvest the proceeds into another qualifying "like-kind" property within specific timeframes.
Key Requirements
| Requirement | Description |
|---|---|
| Like-Kind Property | Both properties must be real estate held for investment or business use |
| Qualified Intermediary (QI) | A third party must hold the proceeds during the exchange |
| Same Taxpayer | The same taxpayer must sell and buy (names must match) |
| Equal or Greater Value | Replacement property must be equal or greater value for full deferral |
| Investment/Business Use | Property must be held for productive use, NOT personal residence |
Critical Deadlines
| Deadline | Timeframe | What Must Happen |
|---|---|---|
| Identification Period | 45 days from sale | Must identify potential replacement properties in writing |
| Exchange Period | 180 days from sale | Must close on replacement property |
| No Extensions | Strict deadlines | IRS does not grant extensions (except federally declared disasters) |
Identification Rules
| Rule | Limit |
|---|---|
| Three-Property Rule | Identify up to 3 properties regardless of value |
| 200% Rule | Identify any number if total value doesn't exceed 200% of relinquished property |
| 95% Rule | Identify any number if you acquire 95% of identified value |
What Qualifies as "Like-Kind"
| Qualifies | Does NOT Qualify |
|---|---|
| Land for apartment building | Primary residence |
| Rental house for commercial building | Property held for sale (inventory) |
| Retail property for office building | Personal vacation home |
| Farmland for shopping center | Foreign real property (for U.S. property) |
| Oil/gas rights for rental property | Personal property (since 2018 TCJA) |
Boot and Taxable Gain
"Boot" is any non-like-kind property or cash received in the exchange:
| Type of Boot | Example | Tax Consequence |
|---|---|---|
| Cash boot | Keeping some sale proceeds | Taxable to extent of gain |
| Mortgage boot | Lower debt on replacement | Taxable as cash boot |
| Unlike property | Receiving personal property | Fair market value is taxable |
Qualified Intermediary Requirements
| Rule | Reason |
|---|---|
| Cannot be related party | No family, employees, or agents |
| Must hold funds | Seller cannot touch proceeds |
| Arm's length | Independent third party required |
| Written agreement | Exchange agreement before sale |
Types of 1031 Exchanges
| Type | Description |
|---|---|
| Simultaneous | Both properties close same day |
| Delayed (Deferred) | Most common; sell first, buy within 180 days |
| Reverse | Buy replacement first, sell relinquished within 180 days |
| Build-to-Suit | Use funds to improve replacement property |
Tax Implications
| Concept | Explanation |
|---|---|
| Deferred, Not Forgiven | Taxes are postponed, not eliminated |
| Basis Carryover | New property takes adjusted basis of old property |
| Depreciation Recapture | May be triggered if you eventually sell for cash |
| Death Benefit | Heirs receive stepped-up basis (taxes eliminated) |
Common Mistakes to Avoid
| Mistake | Consequence |
|---|---|
| Missing 45-day deadline | Exchange fails, full taxes due |
| Touching the proceeds | Disqualifies entire exchange |
| Using same closing agent as QI | May invalidate exchange |
| Buying from related party | Exchange may be disqualified |
| Insufficient replacement value | Partial tax due on boot |
Exam Alert
1031 exchange = TAX-DEFERRED (not tax-free). Critical deadlines: 45 days to IDENTIFY, 180 days to CLOSE. Must use QUALIFIED INTERMEDIARY. Properties must be LIKE-KIND (real estate for real estate). Same taxpayer must sell and buy. Does NOT apply to primary residences or property held for sale.