Frequently Asked Questions

A Tax Deferred Exchange, also known as a 1031 exchange, is a transaction in which an investor defers paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a “like-kind” property. This deferral is allowed under Section 1031 of the Internal Revenue Code.

A tax-deferred exchange is also referred to as a 1031 exchange or like-kind exchange.

Key elements of a tax-deferred exchange include:

• The exchange must be between investment or business properties (personal residences do not qualify).
• The investor must follow specific time limits, including the 45-day identification period and 180-day exchange period.
• A Qualified Intermediary (QI) must hold the proceeds from the sale to ensure the investor does not take possession of the funds, preserving the tax-deferral benefit.

1031 exchanges can be a suitable strategy for real estate investors who want to upgrade their properties and diversify their portfolios without incurring immediate tax liabilities.

No, not all 1031 exchanges involve directly swapping or trading properties with another property owner. In fact, most 1031 exchanges do not operate this way. Instead, they typically involve selling your relinquished property and using a Qualified Intermediary (QI) to hold the proceeds until you purchase a replacement property from a different seller.

This structure is called a delayed exchange, the most common form of a 1031 exchange. In a delayed exchange, there is no need for the parties to trade properties directly; the transactions can be entirely separate as long as you meet the identification and closing deadlines set by the IRS.

No. While there are 1031 exchanges that involve simultaneous closing on the sale and purchase, this is not mandatory.

The sale of the relinquished property and the purchase of the replacement property can happen at different times as long as they comply with the IRS 1031 exchange deadlines.

After selling the relinquished property, you have up to 45 days to identify replacement properties and 180 days from the sale to close on the purchase of the replacement property. These deadlines allow for some flexibility in timing, but the replacement property must be identified and acquired within these windows for the exchange to qualify.

No IRS regulation or IRC provision limits the number of properties involved in a 1031 exchange.

Investors can exchange out of several properties into one replacement property or sell one property and acquire several. Both are perfectly acceptable strategies.

Moreover, the tax code allows several types of property exchanges, such as simultaneous exchanges, reverse exchanges, and improvement exchanges. This allows investors to structure a deal that best suits their situation.

Here’s what you need to know to fully defer the capital gain taxes realized from the sale of a relinquished property (though this is not an exhaustive list):

• The purchase price of the replacement property must be equal to or greater than the net sales price of the relinquished property.
• For full tax deferral, all equity from the relinquished property’s sale must be used to acquire the replacement property.
• Section 1031 does not apply to primary residences and vacation homes. It can only be used for an investment or commercial property.
• You cannot hold the constructive receipt of the exchange proceeds. You must use a Qualified Intermediary (or exchange facilitator) to hold the funds until they are used to acquire the replacement property.

The exchanger will trigger a taxable event if these rules are not followed.

For example, if the purchase price of the replacement property is less than the relinquished property, the difference will be subject to tax. Similarly, any net proceeds you receive that are not reinvested are considered “boot” and subject to capital gains taxes.

This is not to say that the exchange will not qualify for these reasons; partial 1031 exchanges do qualify for partial tax deferral.

For a successful tax deferral, your exchange’s replacement properties must adhere to specific timelines and rules. 

Here is a checklist to help you stay on track when identifying a 1031 Exchange property:

45-day identification period: You must identify potential replacement properties within 45 days of closing on the relinquished property.

Documentation: Before the 45-day deadline, sign and deliver the written document identifying the potential replacement properties to the Qualified Intermediary or exchange accommodator.

You must follow one of three identification rules: 

• Three property rule: You can name up to three properties, regardless of their fair market value.
• 200% rule: You can name more than three properties with an aggregate value not exceeding 200% of the value of the relinquished property, alternatively,
• 95% exception: You can name as many properties as you want with no value limit. However, you must acquire at least 95% of the total value of all the identified properties before the end of the 180-day exchange period.

Yes, reverse 1031 exchanges are legal. However, they can sometimes become complex and require appropriate planning.

Most of our Qualified Intermediary or facilitator partners are owned by banks. This means that they will not handle reverse 1031 exchanges in most cases because liability reasons prevent them from holding title to property on behalf of an Exchanger.

1031 Crowdfunding, LLC can assist you in identifying and vetting a Qualified Intermediary who can handle your reverse 1031 exchange. We can provide guidance on what to look for in a QI and help you ensure they have the experience and expertise to execute your transaction effectively.

In a 1031 exchange, there are two critical time limits you must follow:

• 45-Day Identification Period: You have 45 days from the sale of your relinquished property to identify potential replacement properties. The identification must be in writing, signed, and delivered to the appropriate party (such as the qualified intermediary).
• 180-Day Exchange Period: You have 180 days from the sale of your relinquished property to close on the purchase of one or more of the identified replacement properties. This 180-day period runs concurrently with the 45-day identification period, meaning you must complete the entire exchange within 180 days of the sale.

Both deadlines are strict, and missing either will disqualify the exchange from 1031 tax deferral benefits.

In a delayed exchange, is there any limit to property value?

Yes. Taxpayers must adhere to one of three identification rules for the replacement property.

• Three Property Rule: You can identify up to three properties, regardless of their combined value. Keep in mind that the potential replacement properties must be equal or greater in value to satisfy the tax deferral requirements.
• 200% Rule: If you identify more than three properties, their combined value cannot exceed 200% of the relinquished property’s value.
• 95% Rule: If you identify more than three properties and their combined value exceeds 200% of the relinquished property’s value, you must acquire at least 95% of their total value.

Here are some significant restrictions that apply to both deferred and reverse exchanges that you should be aware of:

• The exchanger cannot control the exchange funds at any point during the exchange. If this rule is violated, the transaction will be disqualified from tax-deferred treatment. The IRS requires exchanges to use a Qualified Intermediary to hold the sales proceeds until the exchange is complete. A Qualified Intermediary is an independent third party that facilitates the exchange of funds in a delayed exchange.
• You cannot act as your own Qualified Intermediary (exchange facilitator). Neither can a person authorized to be your agent (including your real estate agent and tax advisor).
• If cash or other proceeds that are not like-kind property (boot) are received at the conclusion of the exchange, the transaction will still qualify as a like-kind exchange. The boot you receive will be subject to capital gains tax and may also be subject to depreciation recapture.

Yes, property identifications for replacement properties should be made directly to the Qualified Intermediary (QI). While other parties like attorneys, escrow agents, closers, or title companies may be involved in the transaction, they generally do not have the specialized knowledge or experience to handle the specific requirements and documentation related to property identification for 1031 exchanges.

No, these deadlines are set by the IRC and cannot be extended for any reason except by a Presidential Disaster Declaration. The deadlines are not extended even if they fall on a Saturday, Sunday, or legal holiday.

To fully understand the intricacies of 1031 exchanges, refer to our detailed glossary, which provides clear explanations of common terms, such as like-kind property, safe harbors, qualified intermediaries, boot, and replacement property.

You and your tax representative must adjust and track the basis correctly to comply with Section 1031 regulations.

In a like-kind exchange, the gain is deferred but not eliminated. You must calculate and maintain the basis of the new property acquired through the exchange. The basis of the replacement property is carried over from the relinquished property, with certain adjustments. This transfer preserves the deferred gain for future recognition. A side effect of this process is that the depreciable basis is typically lower than if the property had been purchased in a taxable transaction.

When you eventually sell the replacement property (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, will be subject to tax.
Is there a simple rule for structuring an exchange where all the taxable gain can be deferred?
Yes, if you:

• Purchase a replacement property that is equal to or greater in value than the net selling price of your relinquished property, and
• Move all equity from one property to the other.

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At 1031 Crowdfunding, our goal is to empower our clients by educating them. We’re committed to helping you navigate the complexities of 1031 exchanges with confidence. If you need more information or are ready to start your 1031 exchange journey, our team is here to assist you every step of the way.