1031 Exchanges

Under what circumstances would you ever want to exchange property? You might want to exchange a property (held for investment or productive use) if you could defer the payment of a substantial capital gains tax. Sell one property and defer taxes by purchasing another to replace it. Sound good? Indeed, the 1031 Exchange could be a very useful tax shelter for many Americans.

Of course, there are a few rules and regulations set out by the IRS. In general, you cannot exchange a property that is a personal residence unless the residence or a portion of the residence is being used, for example, as a business or a rental or a B&B. Always check with your financial advisor or tax consultant to find out what property will qualify for a 1031 Exchange. You may not exchange personal property, only real property. For more information directly from the exchange industry, you can visit Starker Services or Realty Exchangers.

A leasehold property may be considered a personal property if the lease is shorter than 30 years; if the lease is 30 years or longer, you may be able to exchange a leasehold property under Section 1031. Check with your tax advisor.

The replacement property must be “like kind” property. This term does not mean that the exchanged and relinquished property must be exactly the same type of property, for instance, vacant land for vacant land. “Like kind” refers to the intended use of the property. Therefore, if a property is purchased as a business or investment, it can qualify as a suitable replacement property for business or investment property currently held by the taxpayer. A duplex may be exchanged for bare land, a rental property for retail space, and so on, as long as the intended use is the same.

There are two time deadlines in a 1031 exchange: The replacement property must be identified within 45 calendar days from the closing of the sale of the relinquished property. There is no leeway with regard to this rule and the identification must be made within 45 days, notwithstanding any event – even a natural disaster.

The replacement property must be received by the taxpayer within 180 days after the date on which the taxpayer transfers the relinquished property OR the due date for the taxpayer’s tax return for the taxable year in which the transfer of the relinquished property occurs, whichever is first. However, the taxpayer may obtain extensions of the tax-filing deadline up to, but not exceeding, the full 180 days.

Replacement properties may be acquired in one of three ways:

  1. Three Property Rule: The taxpayer may identify any three properties without regards to their fair market value to replace the relinquished property or properties.
  2. 200 Percent Rule: The taxpayer may identify any number of properties as long as the aggregate fair market value does not exceed 200% of the aggregate value of all the relinquished properties as of the initial transfer date.
  3. 95 Percent Rule: Any number of properties, no matter what the aggregate fair market value may be identified as replacement properties, provided that 95% of the identified properties are acquired.

Fair Market Value is defined as the value of the property as of the earlier of the date the property is received by the taxpayer or the last day of the exchange period and the value of the property is not reduced by any liabilities secured by the property.

The replacement property must have a fair market value equal to or greater than the relinquished property and all of the taxpayer’s equity or more must be used in acquiring the replacement property. The investor must also be prepared to assume equal or greater debt on the replacement property.

There are currently three types of exchanges accepted by the IRS: simultaneous, delayed, and reverse. The reverse exchange is the most complicated but could allow a taxpayer to acquire an ideal investment property before relinquishing any property and still avoid the tax consequence. We’ve gone from a simple idea of exchanging properties and deferring taxes to some quite complex actual transactions. These transactions must fulfill all of the IRS regulations in order to qualify for a tax deferral. It’s important that you locate a qualified intermediary or an accommodator who will act as the facilitator or safe harbor for the properties you intend to exchange AND complete the exchange in a manner acceptable to the IRS, all of course for a fee.

For additional information on many 1031 topics, visit 1031.org or investopedia.com

I am not an expert on 1031 Exchanges and I cannot guarantee the accuracy of this page. I would welcome any information that could make this page more accurate. Please use all of the links given here to more completely understand 1031 Exchanges.

Laure McElwee
Principal Broker/Owner