1031 Exchange Explained

If you currently own a home and are planning on selling, there may be a way for you to put your current home's equity towards the purchase of your new home without having to pay taxes. This is done through a 1031 exchange.

In short, a 1031 exchange refers to a set of rules the IRS introduced in 1990 to allow property owners to sell their property and avoid tax payments by reinvesting the earnings into another like-kind property.

Property Requirements

There are four classifications of real estate according to the IRS:

  1. Property held for personal use (personal property)
  2. Property held primarily for sale (dealer property)
  3. Property held for productive use in a trade or business (business property)
  4. Property held for investment (investment property)

Only investment and business properties qualify for a 1031 tax deferral. Additionally, both the new property and property sold must be used for the same purpose (such as investment or business). Property held outside the USA and its territories does not qualify for exchange with property held within the USA. Vacation homes normally do not qualify unless they are rented, and even then they must pass a yearly use-test.

Additional Qualifications

  • 100% Reinvestment: The IRS requires all of the proceeds to be reinvested into the new property.
  • Qualified Intermediary: The IRS requires that a Qualified Intermediary must handle the transaction. The Qualified Intermediary would process paperwork and be in direct receipt of the funds from the sale until they are transferred to the new property.
  • Time Limits: An investor must identify three potential 1031 exchange properties within 45 days of the close of the sale of the old investment property. Additionally, the investor must close on the exchange property within 180 days of the close of the old investment property.
  • Title Requirements: The IRS requires that the investor hold title in the identical forms in both the old investment property and the new property.

How do I get started?

As with anything related to taxes and financial planning, consult with a trusted exchange intermediary, tax advisor or accountant.