Navigating 1031 Exchange Rules
Understanding Key Requirements and Timelines for a Successful 1031 Exchange
What is a 1031 Exchange?
A 1031 exchange is a way to defer paying capital gains tax on the sale of a business or investment property by using the proceeds to buy a similar investment property of equal or greater value.
Equity 1031 Exchange is a qualified intermediary (QI), the independent third party required by the IRS in both the sale and purchase transactions. Our experience and service will ensure a smooth and successful exchange.
Important Rules for a 1031 Exchange
To qualify for a 1031 exchange, properties must meet certain criteria.
1. Property Usage
The property must be held for investment or business use. Investors may not exchange primary or secondary homes. All other real estate qualifies. Sale property and property for purchase both require deeds (i.e., sell deed and purchase deed).
Property That Qualifies for a 1031 Exchange:
Property used for business purposes
Investment property
Property that you have rented
Land can qualify if it was held for speculation
Property That Does Not Qualify for a 1031 Exchange
Primary residences (explained in IRC Section 121)
Property not intended for business or investment use
Second homes with little or no rental history
Fix-and-flips
FREQUENTLY ASKED QUESTION
DO VACATION RENTALS QUALIFY FOR A 1031 EXCHANGE?
Vacation rentals qualify for 1031 exchanges if they meet the rules of Revenue Procedure 2008-16:
- Property must be rented at fair market rates for at least 14 days each 12-month period for at least two years before its sale.
- Personal use cannot exceed 14 days or 10 percent of the number of days rented each year during this period
- The same rules apply to replacement property.
2. Net Selling Price
To defer all tax, investors must purchase a property/properties of equal or greater value than the net selling price (NSP) of the relinquished property. If replacement properties are less than the NSP, you will be taxed on the difference.
NSP = contract price - (title fees and realtor commissions).
3. Qualified Intermediary
A Qualified Intermediary is an independent third party required by the IRS that acts as the middleman in both the sale and purchase of the properties in the exchange. The Qualified Intermediary, or QI, is required for the exchange and cannot be any agent or fiduciary of the investor. The QI prepares the exchange agreement, escrows the proceeds, and coordinates the exchange with closing agents.
Is a QI necessary for a 1031 exchange?
Yes, according to section 1031 of the Internal Revenue Code, a QI is necessary for the exchange to be valid. Not using a QI or using one who does not comply with key requirements can invalidate the transaction, negate tax benefits, and result in unnecessary penalties. The QI must be contacted to initiate the exchange before closing.
SCHEDULE A MEETING WITH A QUALIFIED INTERMEDIARY
To learn more about 1031 exchanges or to get started today, schedule a virtual meeting with a 1031 exchange specialist or call (239) 333-1031.
4. Key Timing Rules for a 1031 Exchange
Before starting your 1031 exchange, it’s crucial to understand two important timing rules: the 45-Day Rule and the 180-Day Rule. Understanding and adhering to these timing rules is essential for a successful 1031 exchange.
The 45-Day Rule
Start Date: The 45-day period begins when you close on your relinquished property.
Identification Period: You have 45 days to identify up to three replacement properties.
Identification Process: Simply provide the addresses of the properties to your Qualified Intermediary.
Property Value: If you identify only three properties, their combined value can be any amount. If you identify more than three properties, their total value must not exceed 200% of the sale price of your relinquished property.
The 180-Day Rule
Start Date: The 180-day period also begins when you close on your relinquished property.
Closing Period: You have 180 consecutive days to close on one or more of the properties you identified within the initial 45-day period.
Completion: By the 180th calendar day, your exchange must be complete. If you do not close on the properties within this timeframe, the exchange will be null and void, and the funds will be returned to you from the escrow account.
FREE DIGITAL GUIDE
Download our 1031 exchange guide today. You'll have the opportunity to learn even more about timing, key terms, tax benefits of a 1031 exchange, and important rules or common misconceptions.
5. Exchange Types
There are three main types of 1031 exchanges: Standard Exchange, Reverse Exchange, and Improvement Exchange.
Standard Exchange:
In a standard exchange, the sale of a relinquished property is followed by the purchase of a replacement property within 180 days.
A Standard Delayed Exchange occurs when the replacement property closes within 180 days from the sale of the relinquished property. This is the most straightforward and common type of 1031 Exchange.
A Standard Simultaneous Exchange can happen in two ways. The first way involves two parties who “swap” properties with each other. The second way is when the exchanger closes on the sale of the relinquished property and buys the replacement property on the same day.
Reverse Exchange:
The replacement property is purchased before selling the relinquished one, with the same 180-day deadline applying to the sale of the relinquished property.
Improvement Exchange:
Proceeds from the sale of the relinquished property are used to buy and improve the replacement property, with all improvements needing to be completed within 180 days of the sale.
1031 Exchange Example
Susan had a high-end vacation rental in Cape Cod that she inherited twenty years ago. She wanted to sell the property and reinvest into multiple rental properties in Florida to provide a steadier stream of income. Susan went under contract to sell her property for $1,200,000. She consulted with her CPA and was informed that she would owe approximately $105,000 in capital gains taxes if she did not do a 1031 exchange.
Susan’s CPA also advised her that he could not set up the exchange for her and that she would need to engage a Qualified Intermediary (QI) before closing on her sale. She was referred to a QI, Equity 1031 Exchange, and was able to set up her exchange. Equity 1031 Exchange directed Susan to Section 1031 of the Internal Revenue Code which outlines the requirement to complete her exchange within 180 days of closing on her sale and identify replacement properties within 45 days of closing on the sale.
After she closed on her sale, she found four single-family homes to rent in Florida with a combined value of $2,400,000. She identified these to the QI before the 45th day. Susan knew that she needed to apply all of her proceeds towards the purchases and only finance what was required. She found a private lender willing to lend enough funds to cover all the purchases and utilize all of her cash from her vacation rental sale. She closed on all four of the properties before the 180th day.
The Result
Susan was able to purchase four properties in a new market. Because these were single-family homes, she also received a steadier income stream compared to the vacation rental she once had. In addition, she did not have to pay the capital gains taxes on the Cape Cod rental sale since she completed a 1031 exchange.
THE 1031 EXCHANGE*
Relinquished Property Value: $1,200,000 (Basis $500,000)
Replacement Properties Total Value: $2,400,000
Cash Reinvested: $1,200,000
Amount of Loan: $1,200,000
Total Exchange Fees: $2,000
Capital Gains Tax Savings: $105,000
*Numbers have been rounded and closing costs are not included.
Frequently Asked Questions
Have additional questions related to 1031 exchanges? Check out our full FAQs
HOW AND WHEN DO YOU REPORT A 1031 EXCHANGE TO THE IRS?
Form 8824 is used to report a 1031 exchange. You’ll need to fill out this form and attach it to your tax return.
You report a 1031 exchange in the tax year in which the exchange was completed. For example, if you completed the exchange in 2023, you would report it on your 2023 tax return, which is typically filed in 2024.
CAN I AVOID PAYING TAXES FOREVER?
Yes! Simply follow 1031 exchange rules every time you sell one or more properties and buy replacement properties. When you die, your estate forever escapes all capital gain taxes.
CAN I GET MONEY OUT OF THE EXCHANGE TAX FREE?
Yes. Complete your exchange first and after closing there is the opportunity to refinance the new property. It is critical that you wait until the exchange is complete before you begin the process of refinancing.
CAN I HOLD A PARTIAL LOAN ON THE PROPERTY I AM SELLING AND STILL HAVE A TAX-FREE EXCHANGE?
Yes. If payments come to you, they are taxed as you receive them, on an installment sale basis. The balance of your equity is exchanged tax free. If you want the loan to be part of the exchange, determine this prior to closing as the loan has to be to be payable to the QI. You must ensure the loan is paid in full within 180 days and prior to closing on your replacement property if you want those funds to be part of the exchange. Any portion not paid within 180 days is not considered part of the 1031 exchange and is subject to tax.
Why Choose Equity 1031 Exchange?
Our staff has over 50 years of combined experience facilitating 1031 exchanges.
Equity 1031 Exchange has 2 CES® (Certified Exchange Specialists®) on its team.
Equity 1031 Exchange is nationwide. We facilitate 1031 exchanges in every state. Our nationwide presence gives us expertise in exchanges of all types.
We are a proud member of the Federation of Exchange Accommodators (FEA).
Getting Started with a 1031 Exchange
If you’re interested in doing a 1031 exchange with Equity 1031, please complete this form. A member of our team will then contact you within one business day to start your 1031 exchange.
Please note: you must set up your exchange before closing on your property. We request three to five business days to set up a Standard Exchange. Contact Equity 1031 Exchange for timelines on setting up a Reverse or Improvement Exchange.
Schedule a Meeting
If you are looking to do a 1031 Exchange, schedule a meeting with our team to learn more.
What to expect in a 1:1 session with a 1031 exchange representative:
- Get all your 1031 exchange questions answered
- Tell us about your investment property, goals, and timelines to evaluate your options
- Receive insight and education from our experienced 1031 exchange team