What Every Investor Should Know About 1031 Exchanges

Every real estate investor’s strategy includes making smart moves, so it’s no surprise that many take advantage of a 1031 exchange. After all, selling an investment property will often require you to pay taxes on the proceeds — unless you reinvest those proceeds into a new like-kind property. 

This article explores 1031 exchanges and what every investor should know. 

What is a 1031 Exchange?

Often referred to as a like-kind exchange in the industry, a 1031 exchange allows real estate investors to essentially exchange one property for a similar one without paying capital gains tax on the profit from their sale. The rules to determine what is considered a “similar” property are very easy-going, though the rules of these transactions are not. 

This refers to real property only that is considered an investment — not a primary or secondary residence. 

A Step-by-step Overview of a 1031 Exchange

Before you decide to take advantage of this IRS tool, having an overview of what the process looks like can help. 

Find Your Properties 

Before you do anything else, you need to know the property you want to sell and find the property you want to buy. This new property must be like-kind to the property you currently own. Gather the details so that they can be shared when the time is right. Of the properties you choose to buy, you must close on one of them. 

Select Your Qualified Intermediary

Your qualified intermediary is someone who acts as a facilitator of the exchange. This party will handle the transaction from start to finish so you want to make sure that they have plenty of experience with 1031 exchanges. Title companies are often chosen to fill this role. 

Notify the IRS

Use Form 8824 to report the exchange to the IRS. This is completed and filed with your tax return. You will provide the details of the transaction, including the specifics of the properties, the timeline, and the people involved. 

1031 Exchange Timeline

Sticking to the timeline is crucial if you want to complete the transaction and save on capital gains tax. Note that the IRS will not allow any extensions. 

45-Day Rule

From the time you sell your property, you have 45 days to choose an exchange property. This needs to be in writing and must include the legal description of the property, signed, and provided to the seller and/or qualified intermediary. 

180-Day Rule

You will have 180 days from the date you sell your property - or the date your tax return is due - (whichever comes first) to close on the new one. This deadline must be met or you will have to pay the capital gains tax from your sale.  

1031 Rules You Need to Follow

The IRS lays the ground rules for these transactions quite well so that they can easily be followed by investors and those facilitating the transaction. Do not deviate from these rules or you may find yourself owing the IRS money. 

• The exchange property must be of equal or greater value — you cannot downsize your investment using this tool. 

• The properties must also be similar in function. 

• The proceeds from your sale must be held in escrow by your qualified intermediary. 

• In your written letter, you can provide details for up to three properties you would like to buy, but you have to close on one of them. 

There are no exceptions to these rules. 

Let Blue Note Title, LLC Handle Your 1031 Exchange

At Blue Note Title, LLC., we have the experience to guide you through your 1031 exchange, keeping you on track with your timeline and securely holding your money in escrow. And, of course, if you have any questions along the way, just ask.

Contact us today.