1031 Exchanges
“Swap, Don’t Sell — Defer the Tax.”
What Is a 1031 Exchange?
A 1031 exchange (named after Section 1031 of the U.S. Internal Revenue Code) allows real estate investors
to defer capital gains taxes on the sale of investment or business-use property as long as the proceeds
are reinvested in a like-kind property.
It’s a powerful strategy to build wealth, reallocate assets, or diversify a portfolio without the immediate tax hit.
Who Uses 1031 Exchanges?
Real estate investors repositioning portfolios
Landlords wanting to exit active management
Heirs & estate planners aiming to preserve value
Business owners selling commercial real estate
Benefits
Defer taxes (potentially indefinitely if exchanges continue).
Compound wealth by reinvesting full equity.
Rebalance location, asset class, or management level.
Transition from active to passive ownership (e.g., into DSTs…see below for more on DSTs).
1031 Exchange Key Features
Tax-Deferred Real Estate Exchange
- Defer federal (and often state) capital gains taxes.
- Reinvest proceeds into qualifying “like-kind” property (e.g., from a rental duplex to a commercial office).
Must Use a Qualified Intermediary (QI)
- You can’t touch the proceeds directly.
- A QI holds the funds and manages the exchange process. (see below for add’l QI info.)
Strict Deadlines
- 45 Days: Identify replacement property/properties.
- 180 Days: Close on the new property.
- Both timelines start when the relinquished property closes.
“Like-Kind” Defined Broadly
- Properties must be held for investment or business use.
- Residential, commercial, vacant land, and more often qualify.
- Primary residences and flips do not qualify.
Best Practices for 1031 Exchange Success
Start Early with a QI
- Line up your Qualified Intermediary before the sale.
- Review documentation and ensure compliance ahead of time.
Understand Replacement Property Rules
- Identify up to 3 properties (most common method) or more under IRS limits.
- Properties must be of equal or greater value to fully defer taxes.
Avoid Boot
- “Boot” is any cash or non-like-kind property received — it triggers a taxable event.
- Reinvest all proceeds and match or exceed debt on the replacement property.
Know the Timelines Cold
- Day 1 starts when your old property closes.
- Miss the 45- or 180-day mark, and the exchange fails.
Keep Clean Records
- Save all documents from the QI and escrow.
- Ensure the titles match between old and new property (or follow IRS rules for entities/trusts).
Explore Passive 1031 Options
- Use vehicles like Delaware Statutory Trusts (DSTs) to simplify ownership.
- Ideal for aging investors or those leaving active management.
Consult Your Tax Advisor
- 1031s are complex. A tax pro can help with:
- Identifying disqualifiers
- Estimating potential boot
- State-specific rules
Qualified Intermediary (QI)
“The 1031 Gatekeeper”
A Qualified Intermediary (sometimes called an Exchange Accommodator or Facilitator) is a neutral third party that holds and manages the proceeds from the sale of your relinquished property during a 1031 exchange.
IRS Requirement: You must use a QI for your exchange to qualify under IRS guidelines. If you receive or control the funds at any point, the exchange becomes taxable.
Key Responsibilities of a QI
| Role | Description |
|---|---|
| Escrow Agent | Holds sale proceeds in a dedicated exchange account. |
| Document Preparer | Drafts the necessary 1031 exchange documents (exchange agreement, assignment, notice to buyer/seller). |
| Timeline Tracker | Ensures adherence to IRS deadlines (45-day ID period, 180-day close period). |
| Funds Disburser | Releases funds only for the acquisition of identified replacement property. |
| Compliance Gatekeeper | Helps structure the exchange to avoid IRS disqualification. |
What to Look for in a Qualified Intermediary
Experience
Look for firms with a strong track record in 1031s across multiple property types (residential, commercial, DSTs, etc.).
Bonding & Insurance
Choose a QI that carries fidelity bonds, errors & omissions (E&O) insurance, and segregated accounts.
Transparency
Avoid QIs who pool client funds or don’t clearly explain their fee structures.
Secure Banking Practices
Confirm that the QI uses FDIC-insured accounts and works with reputable banks.
Legal & Tax Awareness
While not giving formal advice, a good QI is familiar with IRS rules and red flags that could jeopardize the exchange.