What to Know About 1031 Exchanges
- A 1031 Exchange is for a business or investment property. Both relinquished and replacement properties need to qualify, “Held for the productive use in a trade or business or for investment.” They cannot be a vacation home or a property held for sale (i.e. flip property).
The tax reform law that passed in December 2017 limited exchanges to only real estate.
- The definition “Like-kind” is relatively vague: Raw land can be exchanged for a shopping center, or a ranch home can be exchanged for an apartment building.
- 1031 Exchange Deadlines: 45 days for property identification of replacement property + 135 days to close = 180 day exchange period. A 1031 Exchange has a non-negotiable and non-extendable deadline; 45 days in which to identify a replacement property plus 135 days to process the paperwork which allows for a total of 180 days to close on the new property after the sale of the old.
- Any cash left over after the sale is a taxable “boot,” and will be taxed as capital gain on the sale of your property. Full tax deferred exchange = carrying all equity and debt from the sale to the purchase. Only the following non-recurring expenses may be deducted: commissions, escrow fee, title fee and exchange fee.
- A mortgage and other debt is considered by the IRS. If you have a $1.5 million mortgage on the property you sell, and a $800,000 mortgage on your replacement property, you may have to pay capital gains tax on the difference.
- Title should remain consistent from sale through purchase.
How the 1031 Exchanges Works
- Open a 1031 Exchange prior to close on relinquished property
- Sell the relinquished property
- Identify a like-kind property within 45 days
- Negotiate with the seller of the like-kind property
Agree on a sales price
- Open escrow on replacement property
- Intermediary wires proceeds into escrow just prior to close
- Close escrow on replacement property