ATTENTION REAL ESTATE INVESTORS! Grow your real estate portfolio more efficiently with a 1031 exchange

What IS a 1031 Exchange?

A 1031 exchange, named after Section 1031 of the U.S. Internal Revenue Code (IRC), is a tax deferred exchange of investment real estate that allows real estate investors to sell an investment property  and reinvest the proceeds into another, similar property (referred to as a “like-kind” property), without immediately paying capital gains taxes on the sale. This deferral of taxes allows the investors portfolio to grow more efficiently.

A. Key Features of a 1031 Exchange:

1. Like-kind Property Requirement: The property being sold and the one being purchased must be of the same nature or character, though they don’t have to be identical. (e.g., selling a commercial property to purchase a rental property is permissible). 
2.  Deferral of Capital Gains Tax: Taxes on the sale’s gains are deferred, not eliminated. Taxes become due IF and when the replacement property is sold without further exchanges.
3. Qualified Intermediary (QI): The proceeds from the sale cannot go directly to the investor. Instead, they must be held by a QI to qualify for tax deferral.
4. Strict Timelines: The investor has 45 days from the sale of the original property to identify potential replacement properties, and 180 days to close on it.
5. No Personal Use: Properties in a 1031 exchange must be held for investment or business purposes, not personal use.
6. Equal or Greater Value: To fully defer the capital gains taxes, the replacement property must be of equal or greater value, and all proceeds from the sale must be reinvested.
7. Boot: Any leftover cash or personal property received in the exchange is called “boot,” and is fully taxable.

B. Types of 1031 Exchange:

1. Simultaneous Exchange: The old property is sold, and the replacement property is purchased on the same day.
2. Delayed Exchange: The most common type, where there is a time gap between selling the old property and acquiring the new one.
3. Reverse Exchange: The new property is acquired before selling the old one.
4. Improvement Exchange: Allows the investor to use exchange proceeds to improve the replacement property. 

C. Benefits of a 1031 Exchange:

1. Defers capital gains taxes, freeing more capital for reinvestment.
2. Facilitates portfolio growth and diversification.
3. Enables strategic upgrades to investment properties.

D. Risks and Considerations: 

1. Failure to meet deadlines and rules can result in disqualification and immediate tax liability.
2. Requires proper planning and consultation with tax professionals and legal advisors.

Now that you have learned the basics of a 1031 exchange of investment real estate and its advantages, let’s move on to the second article in our 4-part series, “Combining a 1031 Exchange with a Delaware Statutory Trust.”

Disclosure: For educational purposes only. Not legal or tax advice. Consult your professional advisor/s before taking any action regarding this subject.