Buying Property With 1031 Tax Free Exchange Explained (2024)

FAQs

How does 1031 exchange work for dummies? ›

A 1031 exchange is a strategy in real estate investing where an investor can defer paying capital gains taxes on an investment property when it is sold as long as another "like-kind property" is purchased with the profit gained by the sale of the first property.

A 1031 exchange is a tax-deferred exchange that allows you to defer capital gains taxes as long as you are purchasing another “like-kind” property. This exchange mechanism is used by some of the most successful real estate investors and can be beneficial in a variety of situations.

Section 1031(f) provides that if a Taxpayer exchanges with a related party then the party who acquired the property in the exchange must hold it for 2 years or the exchange will be disallowed.

A vacation home, second home, or any other property used exclusively by the taxpayer for their own enjoyment, and which has no business or investment motive is not eligible for a 1031 exchange.

Suppose you are a real estate investor. You choose to sell your current property with a $150,000 mortgage on it. It sells for $650,000. If you want to meet the conditions for a 1031 exchange, you much purchase a replacement property for at least $650,000.

The two most common situations we encounter that are ineligible for exchange are the sale of a primary residence and “flippers.” Both are excluded for the same reason: In order to be eligible for a 1031 exchange, the relinquished property must have been held for productivity in a trade or business or for investment.

Buyer requests seller's cooperation in such an exchange and agrees to hold Seller harmless from any and all claims, costs, liabilities, or delays in time resulting from such an exchange. Seller agrees to an assignment of this purchase and sale agreement to a qualified intermediary by the buyer.”

What disqualifies a 1031 exchange? A 1031 exchange can be disqualified if the property being exchanged is not used for business or investment purposes, if the exchange is not completed within the specified timelines, or if the exchange does not meet IRS regulations.

The qualified intermediary holds your sale proceeds in escrow until the exchange is complete. Choose your qualified intermediary with care so you don't lose money, miss key deadlines or end up paying taxes.

The Biden Administration has proposed limiting Section 1031 like-kind exchange deferral to a maximum of $500,000 (single taxpayer) / $1 million (married taxpayers) in the budget proposal for 2025.

How soon after a 1031 exchange can you sell? ›

If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable.

Typical DST Returns on a 1031 exchange investment could yield between 5%- 8% of monthly distributions based on your fractional interest.

If you're completing a 1031 exchange, you must reinvest all your profits into your replacement property for it to be completely tax-free. If you don't reinvest the entire amount, the amount left over is immediately taxable.

In fact, there is no minimum holding period for a 1031 exchange property, but the IRS and many advisors recommend holding it for at least two years to avoid scrutiny. The IRS focuses on the investor's intent rather than designating a specific minimum holding period.

Delays can happen for many reasons. If a timeframe is missed for any reason, a 1031 investor can risk disqualifying their entire exchange and may run the risk of heavy tax consequences. It's important to talk with a professional before making decisions on whether or not your property qualifies as a 1031 Exchange.

If you're completing a 1031 exchange, you must reinvest all your profits into your replacement property for it to be completely tax-free. If you don't reinvest the entire amount, the amount left over is immediately taxable.

I had to inform him that there is no DIY (do-it-yourself) in any of this and the IRS will not allow a 1031 tax-free exchange without a 3rd party Qualified Intermediary or Exchange Accommodator to facilitate the exchange.