What is a 1031 Exchange?
A 1031 exchange is a real estate investing tool used to defer capital gains, losses, or capital gains tax that you have to pay at the time of sale. This strategy involves selling an investment property and reinvesting the proceeds in a similar property or properties within a specific timeframe. Investors typically use a 1031 exchange when focused on commercial properties like rental properties, retail, and office spaces.
How Does a 1031 Exchange Work?
When an investor identifies a property to sell, an exchange facilitator is selected to handle the transaction. This is a qualified intermediary who can hold the proceeds of the sale until you identify another property to purchase. Once the initial property is sold, you have 45 days to find your replacement investment and 180 days to purchase it.
Why is a 1031 Exchange Important?
Leveraging a 1031 exchange is a wealth-building strategy. This approach gives you the ability to defer capital gains taxes and diversify your holdings, expand your portfolio, or even realign investments with your long-term goals.
What Qualifies for a 1031 Exchange?
A 1031 exchange is only used for commercial real estate, which includes properties used in a trade or business. This transaction allows you to exchange your investment or property that generates income for another that is “like-kind.” As long as the real estate is in the United States and used in business or held for income or investment, it is considered like-kind.
For example, if your existing investment property is an apartment complex, you could sell this property and then purchase another apartment community. Or you could invest in a retail plaza, office space, or even a vacant lot using a 1031 exchange. As long as it’s commercial real estate for investment, you can leverage this approach to defer tax liabilities.
Understanding 1031 Exchange Rules
Know the Different Types of 1031 Exchanges
The five common types of 1031 exchanges used by real estate investors include:
- Delayed exchange: Sell one property and purchase a replacement property (or properties).
- Delayed/simultaneous exchange: Sell a replacement property and current property at the same time.
- Delayed reverse exchange: Purchase a replacement property before the sale of the current property.
- Delayed build-to-suit exchange: Replace the current property with a new property that is built based on the investor’s needs.
- Delayed/simultaneous build-to-suit exchange: Purchase a built-to-suit property before the sale of the current property.
Replacement property must be of equal or greater value
Real estate investors need to find a replacement property—or properties—that are like-kind or of equal or greater value to the property they are selling.
Identify a replacement property within 45 days
The IRS gives a 45-day window, which isn’t a lot of time. That’s why real estate investors need to plan. Ideally, a replacement property is identified before the sale of the current property.
Purchase a replacement property within 180 days
Be aware that the IRS counts every day–not only business days–including weekends and holidays for the 180-day time frame.
Mattingly Ford Title
The team at Mattingly Ford Title can prepare all the documentation needed for virtually any commercial transaction, including a 1031 exchange.
