A 1031 exchange, or like-kind exchange, lets real estate investors defer capital gains and depreciation recapture taxes indefinitely. But these exchanges are more complicated than just selling one property and buying another.
Besides the rules you should know before completing a 1031 exchange, there’s the issue of timing. Here are the time-related rules of 1031 exchanges, as well as some of the other key principles you should know.
When do you need to start shopping?
When you sell a property and intend to complete a 1031 exchange, the proceeds from the sale must be transferred to a qualified intermediary. The intermediary agrees to hold the funds until they're transferred to the seller of a property that you buy.
From the day the sale of your investment property closes, you have 45 calendar days to identify up to three replacement properties.
This can be more difficult than it sounds, especially in a seller’s market. I suggest looking right away, even though you have 45 days to complete this part of the process.
When do you need to buy a new property?
Here’s the most important date. You need to complete the 1031 exchange
- within 180 days of the sale of the original property or
- by the due date of your tax return for the year of the original sale (including extensions).
You must close on a replacement property by the earlier of those two dates.
Let’s say you sell an investment property on April 1, 2019. You need to identify potential replacement properties in 45 calendar days, or by May 15. Then, 180 days after the sale, or by September 27, 2019, you need to finish the purchase of a replacement property. This completes the 1031 exchange.
It’s also possible to do a reverse 1031 exchange where you acquire a new property before you sell one. In this case, you have similar deadlines. You need to identify the property you’re going to sell within 45 days of the acquisition and complete the exchange within 180 days.
Other important rules to know
There are several other rules and principles investors should know before completing a 1031 exchange.
For example, your sale price and the amount of financing you get for the new property must be as much or more than the equivalent amounts for the property you sold.
If you sell an investment property with a $300,000 mortgage for $500,000, your new property needs to exceed both of those figures. However, you can buy more than one property to meet these requirements.
A 1031 exchange is also only valid for like-kind properties. That means you usually have to buy investment real estate with proceeds from investment real estate. You can’t sell an investment property, buy a personal residence, and call it a 1031 exchange to avoid paying taxes.
For an overview of all the rules you need to know, be sure to check out our 1031 exchange page. If you're uncertain about anything in your situation, talk to a tax attorney or other tax professional. A 1031 exchange can save you a lot of money. So take the time and do the research necessary to get it done right.