What Is a 1031 Exchange?

A 1031 exchange is a way to sell investment or business real estate and defer paying capital gains taxes by reinvesting the proceeds into other qualifying real estate. The name comes from Section 1031 of the Internal Revenue Code.

For the tax implications of a 1031 exchange, seek advice from a licensed tax professional.

What Does a 1031 Exchange Look Like in Practice?

Suppose you own a rental property:

• You bought it for $300,000.
• You sell it for $600,000.
• Normally, you may owe capital gains and depreciation recapture taxes on the sale.
• Instead, you have the sale proceeds transferred to a Qualified Intermediary (QI).
• You use those funds to purchase another investment property for, say, $700,000.

If structured properly, the tax on the gain can generally be deferred rather than paid at the time of the sale. It's extremely important that you consult with a 1031 professional before you complete the sale.

Key Terms

Qualified Intermediary. A licensed company that can hold the funds in escrow in between the sale and the purchase of the replacement property.

Relinquished property. The property the taxpayer is selling.

Replacement property. The property the taxpayer is purchasing after the sale occurs.

What Property Qualifies?

Property being used for rental or business purposes. It cannot be a primary residence.

Frequently Asked Questions

Do I hold the funds from the time the property sells to the time I close on the new property?
No. A Qualified Intermediary must hold the funds. The taxpayer cannot touch the funds or the exchange may be compromised, and the IRS has very strict rules related to the funds.

How long do I have to identify a new place to buy?
45 days. The clock begins when the relinquished property closes and funds.

How long do I have to complete the purchase of the replacement property?
180 days.

I am selling a condo that is a rental, but I want to buy land to build a rental. Can I do that?
Yes, typically you can. The IRS requires a "like-kind" exchange. Real estate to real estate is the bar. Consult with a 1031 professional about specific questions.

Have questions about a referral to a Qualified Intermediary, or want to know more about 1031 exchanges? Our team at Luminary Title Group is happy to walk through the options with you before you get to the closing table.