Behold, Tax Season

« Back to Home

Everything Real Estate Investors Should Know About 1031 Exchange Rules

Posted on

It is important for any business owner to know about all the available tax breaks that they can claim, but real estate investors should be especially careful with their tax breaks to ensure they are not paying unnecessary (and costly) property taxes. A 1031 exchange is one such tax break that can help real estate investors save thousands on their taxes when filed properly. 

What Is a 1031 Exchange?

A 1031 exchange is a type of tax break that real estate investors can claim when they sell one property and reinvest the profits from the first property into another, similar property. When this exchange occurs, the investor does not face any immediate tax consequences from the new purchase. In addition, the owner can choose to defer the capital gains taxes.

Five common types of 1031 exchanges include: 

  • Delayed exchange
  • Delayed/simultaneous exchange
  • Delayed reverse exchange
  • Delayed build-to-suit exchange
  • Delayed/simultaneous build-to-suit exchange

In order to qualify for a 1031 exchange, the investor must remain in compliance with the 1031 exchange rules defined by the IRS including property type, using a qualified intermediary if necessary, and filing all documents within the designated timeframe.

Both Properties Must Be of "Like-Kind"

The first rule of a 1031 exchange is that both properties involved in the exchange must be of "like-kind," meaning that they have roughly the same classification, characteristics, and price. For example, if the first property is a residential property in the United States, the replacement property should also be a residential property in the United States that is selling at an equal or greater value.

Partner With a Qualified Intermediary (QI)

A Qualified Intermediary is a qualified financial professional, such as a CPA, real estate attorney, or bank, that agrees to hold the funds from the originating sale until the time of the final sale. The most common exchange, a delayed 1031 exchange, requires the use of a QI; however, not all 1031 exchanges require a middleman. In a delayed exchange, the original property is sold first, then the replacement property is identified and purchased within the required timeframe. 

File Paperwork Within The Deadline

Finally, it is essential to follow the timeline set by the IRS during a 1031 transaction. There are two key deadlines that must be followed to remain in compliance with 1031 exchange requirements: 45 days, and 180 days. The first deadline requires an investor to inform the IRS of the exchange within 45 days of the original sale. This notification must identify the potential replacement property. The final sale of the replacement property must be closed within 180 days of the original property sale. 

For more info about 1031 exchange rules, contact a local company.