1031 Exchange

Allows you to buy, sell and get cash out of real estate without owing a penny in taxes, no matter how big your gain.


Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to defer paying the tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange.

In order to defer 100% of your capital gains tax liability, 2 requirements must be met. First, all the cash generated from the sale of the relinquished property (the property being sold) must be reinvested into the replacement property (the new property being acquired) AND secondly, the value of the replacement propert(ies) must be equal or greater in value to the relinquished property. These requirements must be met if you want to defer ALL your capital gains taxes. It is still possible to trade down and pay some capital gains taxes (which can still be better than paying ALL the tax).

The Basic Rules:

- Property Qualifications. Any type of real estate can be exchanged for any other type of real estate and all the properties involved in an exchange must be held for investment or business purposes.

- Timeline. There is a maximum of 180 days to complete an exchange. The countdown begins on the close of escrow of the relinquished property. The purchase of replacement property must be completed – that is closed and recorded before midnight of the 180th day.

- Identification. Identification of all potential replacement properties is required on or before day 45 of the exchange. Identification must be in writing and signed, and the description of the properties must be unambiguous (that generally means a property address or its legal description). The property identified does not have to be under contract, and you do not have to acquire everything that you identify. However, you are NOT allowed to acquire anything other than the propert(ies) that you identified.

  • 3 property rule: The easiest and most commonly used identification rule. You can identify any 3 replacement properties (anywhere in the United States and of any value) and may acquire any or all of those properties.
  • 200% rule: For those that want to identify more than 3 properties, you can use the 200% rule. Any number of replacement properties can be identified, as long as the total fair market value of the combined properties does not exceed 200% of the relinquished property.
  • 95% rule: Not too commonly used by investors. The 95% rule allows you to identify more than 3 properties with a total value that is more than 200% of the relinquished property, BUT (and it's a big "but") only if you acquire at least 95% of the value of all the properties identified. That essentially means you have to close on everything you identified in order to make this rule work.

- Qualified Intermediary (QI). You cannot have actual or constructive receipt of any money – if you touch the money (even if it's only for a few minutes or hours), you'll have to pay the taxes. A QI is used to hold your funds, provide written instructions to closing officers, prepare the exchange agreement and other exchange documents and insulate you from any "constructive receipt" issues. The IRS does not permit your accountant, attorney or any type of agent to be your QI.

- Types of Exchanges. Investors have the ability to structure 1031 exchanges in several ways.

  • Simultaneous Exchange: The exchange of the relinquished property for the replacement property occurs on the same day, with concurrent closings. It is possible to complete a simultaneous exchange without a Qualified Intermediary, but it is difficult (due to IRS regulations and "constructive receipt" issues) and not recommended.
  • Delayed Exchange: The most common type of exchange, allowing investors to sell a property and then acquire a replacement propert(ies) within 180 days.
  • Reverse Exchange: Allows investors to acquire replacement property prior to selling the relinquished property. It is more complicated as investors cannot own both the replacement propert(ies) and (soon to be) relinquished property at the same time, so QIs typically require more advance notice and charge higher fees for this type of exchange.
  • Build-to-Suit Exchange (Construction/Improvement Exchange): This technique allows investors to build on or make improvements to the replacement propert(ies) using the exchange proceeds. The challenge with this type of exchange is that all the exchange funds need to be spent on or before the 180th day of the exchange.
  • Foreign Exchange: Foreign real estate can only be exchange for other foreign real estate. It does not matter where the investor buys or sells, as long as it is non-U.S. property for non-U.S. property.
  • Personal Property Exchange: Exchanges are not limited to real property. Personl property can also be exchanged for other personal property of a like-kind or like-class.

- Contract Verbiage. If you are planning on completing a 1031 exchange, you can add the following verbiage to your offers and purchase contracts:

  • When Selling: Buyer is aware of Seller's intent to complete a 1031 exchange and agrees to cooperate, at no additional cost to Buyer.
  • When Buying: Seller is aware of Buyer's intent to complete a 1031 exchange and agrees to cooperate, at no additional cost to Seller.

The information provided is meant for general informational purposes only and it is not to be construed as finance, tax, or legal advice. Please note that individual situations can vary and therefore, please consult your attorney, tax advisor or qualified intermediary for specific advice and counsel.