Your Guide to 1031 Exchanges: Upgrade to a Tax-Deferred “Replacement Property”

Article by:
Steve Chacon
First American Exchange Company
(303) 876-1161
schacon@firstam.com

As a large property owner or real estate investor, you might be familiar with 1031 exchanges. As a newcomer to investing, or as someone who is preparing to sell a long-held piece of real estate, you might not be. Either way, it’s important to understand the opportunities a 1031 exchange can offer you during your next real estate transaction, and you should consider taking action quickly. President Biden’s new tax proposal dissolves the possibility of deferring taxes on property gains over $500,000.

First, what exactly is a 1031 exchange?

Simply, it’s a process that allows you to sell an investment property (the key word here being investment) and then roll the proceeds into the purchase of a new investment property, preferably of equal or greater value, to defer all capital gains taxes. 

Am I eligible for a 1031 exchange?

If you plan to take advantage of a 1031 exchange, it’s important to understand which types of properties and transactions are eligible. Your property must be an investment property; 1031 exchanges do not apply to primary personal residences. Investment properties are real estate purchases used to generate profit, such as office buildings, ranches, farms or rentals. If you’re looking to fully defer the tax ramifications of the sale, you’ll need to roll the money into the sale of a property that is of equal or greater value than the one you’re selling. This isn’t a requirement, but using the money to purchase property that costs less than the original will leave some tax exposure. 

How do I accomplish a 1031 exchange?

There are specific steps you must take in order to take full advantage of the 1031 exchange tax deferment and it’s important to note that timing is paramount. 

1. Sell your property. This obvious first step starts the snowball process of rolling the money into a new investment property. 
2. Identify a qualified intermediary (QI), or middleman. While you don’t have to use a QI for the sale, the IRS does require some sort of exchange facilitator. A QI will have experience in this type of transaction, and will help ensure it is done properly. QIs typically charge between $800 – $1500 for this service. 
3. Find up to three new properties. Again, timing is key here. Upon the sale of your property, you’ll have a 45-day window to identify up to three “like-kind” new properties. 
4. Close on a new property. You will have 180 calendar days from the sale of the original property until you close on the purchase of the new or replacement property. Look to your QI to help manage this timeline. 

Most importantly, don’t wait! Contact your real estate professional today to learn more about possible 1031 exchange opportunities. It might be the perfect time to invest in the ranch, farm or hunting property of your dreams.