About 1031 tax deferred exchanges
A 1031 tax-deferred exchange is a provision in the U.S. tax code (Section 1031 of the Internal Revenue Code) that allows real estate investors to defer capital gains taxes when selling an investment property, as long as they reinvest the proceeds into another like-kind property.
What are the rules for a 1031 exchange?
The Key Rules of a 1031 Exchange are:
- Like-Kind Property – The new property must be similar in nature and purpose (e.g., investment real estate for investment real estate).
- Same Taxpayer – The name on the new property’s title must match the name on the sold property.
- Qualified Intermediary (QI) – The seller cannot take possession of the proceeds; instead, a QI must hold the funds until the replacement purchase.
- Strict Timelines:
- 45 Days to identify potential replacement properties.
- 180 Days to complete the purchase.
- Full Reinvestment Required – To fully defer taxes, all proceeds must go into the new property, and debt must be replaced with equal or greater debt.
When are Taxes Due in 1031 Tax Deferred Exchanges?
In a 1031 exchange, capital gains taxes are deferred, not eliminated, as long as the transaction follows IRS rules.
Taxes on a 1031 exchange become due when:
- Boot is Received – If you receive cash or other non-like-kind property in the exchange, that portion is taxable.
- You Sell the Replacement Property Without Another 1031 Exchange – When you eventually sell without reinvesting through another 1031 exchange, capital gains taxes are due.
- Debt Reduction Occurs – If the mortgage on the replacement property is lower than the one on the relinquished property, the difference (boot) may be taxable.
- Failure to Follow 1031 Rules – If timelines (45-day identification, 180-day closing) or reinvestment requirements aren’t met, the exchange is disqualified, and capital gains taxes are due.
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