When it comes to real estate and real estate investing, there are many different terms to be aware of. One of those terms is a 1031 exchange. Named after Section 1031 of the Internal Revenue Tax Code, many investors use 1031 exchanges to defer capital gains taxes and build wealth.
Let's take a deeper look into 1031 exchanges, their rules, and critical timelines to be aware of if you're considering using them.
What Is A 1031 Exchange?
Essentially, 1031 exchanges swap one investment property for another property of equal or higher value while deferring paying the capital gains tax on the profit. Many investors use this method to upgrade properties without paying taxes on their proceeds.
There's no limit to how frequently you use a 1031 exchange, and you can roll over the gain from one investment to another. Even if you have a profit on each swap, you can avoid paying taxes until you decide to sell for cash.
1031 Exchange Rules
In order to use a 1031 exchange, the property must meet specific requirements:
- The property you're looking to swap must be "like-kind" to the original property, meaning both properties must be used for the same purpose/function.
- The net market of the property you're purchasing must be an equal or greater value than the property you're selling.
- Both properties must be purchased by the same party/taxpayer. If they are different people, the exchange won't be valid.
- 1031 exchanges can only be used on investments or business properties. Personal residences can't be swapped.
- The exchange must follow the 1031 exchange timeline, which we will discuss below.
Key Timelines
The IRS Code requires real estate investors to follow these timelines to qualify for a 1031 exchange.
- 45-Day Rule: Within 45 days from the date the relinquished property is sold, you must designate the replacement property as a property you intend to acquire in the exchange.
- 180-Day Rule: Within 180 days from the date the relinquished property is sold, you have 180 days to close on the purchase of the replacement property.
As a real estate investor, a 1031 exchange is a great method to save money and allow you to build your portfolio. If you have any questions about 1031 exchanges, reach out to me! I'm always happy to help.
