1031 Exchange Basics

A 1031 exchange is a legal way to defer capital gains taxes while you climb the real estate investment ladder. With a 1031 exchange, you can sell a real estate investment, purchase another, and avoid paying capital gains tax in the process. While there are some bureaucratic requirements to be followed, these exchanges offer investors an important tool to defer capital gains tax and reinvest their money.

What kinds of properties are eligible?

All investment properties are eligible. You are free to mix and match various real estate categories in an exchange. Land, apartments, single-family homes, and commercial real estate are all eligible. However, you cannot use the exchange for your primary residence or vacation property.

How does it work?

When you perform a 1031 exchange, you commit the proceeds from the sale to a new purchase, putting the funds in escrow between closings. In most cases, you will need to retain a professional “Qualified Intermediary” (QI) to hold the funds and prepare the documentation that your accountant will need.

What can I buy with 1031 exchange funds?

You may purchase any other real estate in the United States. The new property must be specifically identified no later than 45 calendar days after your sale. You then must close on the purchased properties within 180 days. You can even by multiple replacement properties with one sale’s proceeds – as long as you meet the deadlines.

What if I want some money back?

If you take any money from the sale closing, it is considered “boot,” and you will pay capital gains tax on that amount. Taking a large boot withdrawal will limit the benefits of doing the exchange.

So, what’s the strategy?

Generally speaking, 1031 exchanges are best used to climb the investment property ladder. Purchasing more expensive (or more numerous) properties – and taking no boot in the process – maximizes the tax benefits, deferring the capital gains completely.

Each situation is different, and the best strategy depends on your goals and the specific figures. If you are interested in a 1031 exchange, we can help. Contact us for more information or to determine whether a 1031 exchange could help you.