1031 Exchange Basics: A Plain-English Guide

A 1031 exchange lets you sell investment real estate and buy other investment real estate without paying tax on the gain at the time of the sale. The tax isn't forgiven. It's deferred into the new property, and you can keep deferring it with future exchanges.

It's named after Section 1031 of the Internal Revenue Code, and it's one of the most widely used tools in real estate investing.

Why investors use it

When you sell an investment property outright, part of your proceeds goes to federal and state tax on the gain and on the depreciation you've taken. With an exchange, that money stays invested. Investors use exchanges to move into a different market, trade a management-heavy property for something simpler, consolidate several properties into one, or spread one property's equity across several.

What qualifies

Both the property you sell and the property you buy need to be real estate held for investment or business use. "Like-kind" is broad: a rental house can be exchanged for an apartment building, land, a retail building or a fractional interest such as a Delaware Statutory Trust.

What doesn't qualify: your primary residence, property you bought to flip, personal property like equipment or vehicles, and ownership interests in a partnership or LLC. U.S. property also can't be exchanged for foreign property.

The two deadlines

Both start the day your sale closes and run at the same time:

• 45 days to identify your replacement property in writing to your Qualified Intermediary. Most investors identify up to three properties. You can identify more than three under the 200% rule.

• 180 days to complete your purchase. Day 180 is the last possible day to close, and you have up to and including that date to complete your replacement purchase or purchases. If your tax return is due before day 180, file an extension to keep the full period.

Weekends and holidays count. The only extension is IRS relief for federally declared disasters.

The Qualified Intermediary's role

You can't receive the sale proceeds yourself, even briefly. A Qualified Intermediary holds the funds between your sale and your purchase, prepares the exchange documents, and works with your closing agents on both ends.

The exchange has to be set up before your sale closes. Once the proceeds are paid to you, the sale can't be converted into an exchange.

Taking some cash

If you keep some cash or buy a less expensive property, you can still do a partial exchange. You'll pay tax on the portion you don't reinvest, and defer the rest. To defer everything, buy at least as much as you sold and reinvest all of your net equity.

A simple example

You sell a rental condo for $600,000. Your QI holds the proceeds. Within 45 days, you identify two duplexes and a small retail building. Four months later, you close on one of the duplexes for $650,000, using all of your exchange funds plus a new loan. Because you bought more than you sold and reinvested everything, your gain stays deferred.

Getting started

If you're thinking about selling, talk with your CPA about the numbers and connect us with your closing agent once you're under contract. We can typically have your exchange set up the same day.

APX 1031 is a Qualified Intermediary. We don't provide tax or legal advice; talk with your CPA or attorney about your situation.