A 1031 exchange is a real estate investment tool that allows investors to defer capital gains tax from the sale of real estate. The reason I mention “investors” is because the property must be for investment purposes. The property cannot be your primary residence. The investor sells his or her investment property, the proceeds from the sale are used to purchase another property, and the investor can defer paying tax on the profit from the sale.
The process of a 1031 exchange will involve hiring a 1031 exchange intermediary who would become part of your real estate closing. Once your sale closes, the closing proceeds are sent to the 1031 exchange intermediary who holds the proceeds until you find another property to purchase. You cannot have any control over the proceeds while the proceeds are with the 1031 exchange intermediary. At the closing of your purchase, the 1031 exchange intermediary wires the proceeds from your sale to the closing agent for your purchase. You will not need to pay capital gains taxes on the profit from the sale if all the profit is invested in a new property.
For property to qualify as 1031 exchange property, the following elements apply:
- Exchange – You must be exchanging your property for another like-kind property for investment or business purposes.
- Like-kind – All real estate is like-kind to all other real estate. Thus, your real estate will likely qualify as a 1031 exchange if you are selling your real estate and then buying any other real estate if there is an investment or business purpose to the purchase.
Examples of like-kind exchanges:
a. Single-family house for raw land.
b. Apartment building for a retail center.
c. Office building for a warehouse.
d. Four-plex for a TIC interest in an office building.
Examples of non-like-kind exchanges:
a. Personal residence for other real estate.
b. Vacation home (exception if vacation home is rented for at least 14 days in a year and the property is not used as owner’s residence for longer than the time it is rented) for other real property.
c. Real estate for stocks, bonds, or other securities. - Purpose – The purpose of the property must be for investment or business. You cannot do a 1031 exchange for your primary residence. Examples of property used for investment or business purposes are rentals or property used in your business.
- Timeframe – You have 45 days to identify a property to purchase and 180 days to close. There are no extensions for the dates.
- Value – The value of the property you intend to purchase must be equal or greater in value to the property you sold.
- Same Taxpayer – The taxpayer that sells must be the same taxpayer that buys with a few exceptions:
a. Disregarded single-member LLC to the sole member.
b. Grantor to grantor’s revocable living trust.
c. If taxpayer dies during exchange, the taxpayer’s estate or trustee may complete the exchange.