A 1031 exchange allows an investor to sell a property and reinvest the proceeds in another property without having to pay (i.e. deferring) both capital gains and depreciation recapture taxes on profits from the sale. It is most often used for investments in real estate, but can be applied to other assets. Please see our eBook What is a 1031 Exchange for additional background.
Generally, if your real estate is used for a business or held as an investment property it will qualify.
No, you cannot use a 1031 exchange on your primary residence.
The simple answer is almost any type of investment real estate you want. The IRS generally considers all investment properties to be “like-kind”. For example, raw land can be exchanged for an office building, a strip mall can be exchanged for an industrial building or a rental home exchanged for one or more fractional 1031 properties.
There are two deadlines to know. First, your replacement property must be identified (not purchased) within 45 calendar days from the date you sell your property. Second, you must complete the purchase of your replacement property within 180 calendar days from date of the property you sell. These timeframes are set in stone, the IRS does not grant extensions.
There are three different rules when identifying replacement properties. The rule you choose to follow doesn’t matter, as long as you choose one.
3-Property Rule: You can identify up to three potential replacement properties, as long as you purchase at least one of these within the 180-day timeframe. Most investors focus on acquiring one of the three, with the other two serving as back-up options. This is the most commonly used rule.
200% Rule: More than three properties may be identified as long as their combined value does not exceed 200% of the value of property you sold.
95% Rule: More than three properties may be identified as long as you acquire at least 95% of the total purchase price of these.
In order to defer all your capital gains taxes, the replacement property must have a purchase price and mortgage balance equal to or greater than the property you sold. See the Realized 1031 Calculator to check requirements on your potential exchange.
No, investors are not required to reinvest 100% of the money received from the sale of their property. However, the amount you choose not to reinvest is subject to capital gains and depreciation recapture taxes.
To be eligible for a 1031 exchange, properties must be considered “like-kind”. Property located outside of the U.S. is not considered “like-kind” to property located within the U.S. However, property located outside the U.S. is considered “like-kind” to other property located outside of the U.S. For example, a U.S. investor could exchange a property in Canada for one in Mexico under a 1031 exchange, but could not exchange the Canadian property for one in the U.S. A law has passed that supports exchange of a domestic property with a property located in a U.S. territory. Investors considering exchanges involving properties located in foreign countries should consult a legal professional.
The cost of a 1031 exchange varies according to the cost of the qualified intermediary. A qualified intermediary can generally cost anywhere from $300 to $3,000 or more, depending on demand and complexity of the exchange. It is important to note that when choosing a qualified intermediary, avoid evaluating based solely on price.