A 1031 exchange is the IRS-approved process that allows a real estate investor to sell a property and reinvest all of the proceeds into a new property without paying capital gains taxes.

• Defer capital gains taxes. By deferring capital gains taxes, a real estate investor retains more money that can be put towards the next property investment.
• Greater investment compounding. Retaining all of the gains from a property allows an investor to put more money to work resulting in greater compounding of the investment.
• Greater cash flow. Exchanging into a larger property tax-free enables the investor to exchange into larger cash flows.
• Flexibility to change, diversify, or consolidate real estate portfolio. Investors may want to change the type or number of properties in their portfolio for any number of reasons ranging from the demands of the property to estate planning. The 1031 exchange allows the investor to make these changes without paying capital gains taxes.
•  

• Both the relinquished and the exchange properties must be used for investment or business purposes. Personal residences do not qualify for a 1031 exchange.
• Also, the relinquished and exchange properties must be “like kind”. The IRS’s definition of “like kind” is properties that are “of the same nature or character, even if they differ in grade or quality.” This is to be understood as “real property”, which can include retail, office, industrial, multifamily, self storage, land, and any other kind of real property.

Many types of exchanges exist, but the timeline for the typical delayed 1031 exchange requires from the date that the relinquished property is sold, replacement properties must be identified within 45 days and the purchase of the replacement property be completed within 180 days.

The Exchangor is required to provide “unambiguous description” of the potential replacement properties. The Exchange must identify the potential replacement properties on or before the 45th day after closing on the relinquished property. When identifying more than 1 potential replacement property, the Exchangor must satisfy one of the following guidelines:

• 3-property rule = Identify up to three properties of any value with the intent of purchasing at least one.
• 200% rule = Identify more than three properties with an aggregate value that does not exceed 200% of the market value of the relinquished property.
• 95% rule = Identify more than three properties with an aggregate value exceeding 200% of the relinquished property, knowing that 95% of the market value of all properties identified must be acquired.

Yes. The IRS expressly allows 1031 exchanges as recorded in Section 1031 of the U.S. Internal Revenue Code.

No, not necessarily. 1031 exchanges “defer”, but do not eliminate capital gains taxes. The cost basis of the property sold is transferred to the property acquired. If the acquired property is sold in the future, capital gains taxes will be owed.

A common real estate investment strategy is to defer capital gains taxes for the investor’s lifetime. Then, upon the investor’s death, the property will be inherited by his or her heirs at a stepped up basis and no capital gains taxes will be owed.

No. The IRS requires that a 1031 exchange be facilitated by an outside third party known as an intermediary or accommodator. Summit Exchange Services is a qualified intermediary.

As early as possible. We are happy to answer any questions to make sure everything is in place prior to the sale of the exchange property.

Yes, it is possible to do a partial 1031 exchange, but you will be taxed on the amount not exchanged into the new property. An example of this is selling a property and exchanging into a property of a lesser value. The difference between the property sold and the property purchased will be received back as cash and will be taxed. This cash difference that is received by the investor is called “boot”.

Yes. The exchangor must remain within the 1031 time restrictions and follow the rules for identifying replacement properties.

Yes. The exchanger must remain within the 1031 time restrictions and follow the rules for identifying replacement properties.

No. But thankfully, the IRS has Section 121, the “Primary Residence Exclusion”, that allows an individual to sell his or her primary residence and not pay capital gains taxes on gains up to $250,000. Married couples can exclude up to $500,000 of gains. In order to gain this benefit, the home owners need to live in the property for a total of 2 of the last 5 years.

Yes. International properties can be exchanged for other international properties. Property located in the United States is not considered “like-kind” with property located in a foreign country. Section 1031 allows domestic-to-domestic, and foreign-to-foreign.

Give us a call. We’d be happy to answer any questions that you may have.

Also, the IRS has made additional resources available:

Like-Kind Exchanges Under IRC Section 1031