Basics of a 1031 Exchange

Basics of a 1031 Exchange

  • To structure a 1031 Exchange property under I.R.C. Section 1031, there are some basic requirements that a taxpayer must meet.

  • The property being sold and acquired through the transaction must be “property held for productive use in a trade or business or for investment”. This means that personal residences and properties that are used personally by the owner as a vacation home would not qualify. You should always be holding the property as an investment and showing it as such on your tax return. If you are selling multi-family, raw land, commercial or any other type of real property, it should be considered as investment property. As always, please consult with your tax professional to make sure that is being shown as such on your tax return.

  • There is a like-kind requirement under Section 1031 which requires that you sell real property held as an investment and purchase new real property held for the same purposes. These properties can be residential, commercial, raw land, farm and ranch etc. As long as the properties are both in the Unites States (or some qualifying territories), it should qualify for 1031 treatment.

  • The taxpayer must structure the transaction as a 1031 Exchange. This means that in all real estate contracts you disclose your intent to do a 1031 Exchange to all parties. And the IRS also requires that you use a Qualified Intermediary (QI) like Security 1st Exchange to help facilitate the transaction. You must reach out to us before the closing of any transactions to prepare necessary paperwork. And as QI, we will also hold the funds from your sale until they are needed for the closing of your purchase. At that time, we will transfer the necessary closing funds to your closing agent.

  • To achieve full tax deferral, the property that the taxpayer purchases as their replacement must be equal or greater in value, equity, and debt (or the debt can be replaced with their own cash) than the property that was relinquished. If this requirements are not met, the taxpayer may still defer some of their taxes, but they will most likely have some taxable liability.

  • Lastly, there are timeframes tied to a 1031 Exchange that you MUST adhere to:

      A taxpayer doing an exchange has 45 calendar days from the closing of the relinquished property to identify their replacement property. The taxpayer must properly identify all replacement properties to be acquired within this period.

      The taxpayer also has 180 calendar days from the closing of the relinquished property to close (take ownership) of the replacement property.

Once you understand the basics of the 1031 Exchange, the process is simple. Just always consult with a Qualified Intermediary like Security 1st Exchange to make sure that everything is handled properly.