1031 Exchange FAQs: Answers from a Qualified Intermediary

What is a 1031 tax deferred exchange?

A 1031 exchange is the swap of one investment property for another like-kind property without paying capital gains tax or depreciation recapture tax.

How long have 1031 exchanges been around?

1031 exchanges have been around for more than 100 years, since 1921.

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Why is it called a 1031 exchange?

The name 1031 exchange is derived from U.S. Tax Code, Title 26, Section 1031. It says: "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind […]”.

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How many types of 1031 exchanges are there?

There are 4 types of 1031 exchanges:

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1. Forward Exchange: In a Forward Exchange, an investor sells a property first, then buys within 180 days.

2. Reverse Exchange: Ina Reverse, an investor buys first, then sells within 180 days. This is done utilizing a “parking arrangement” whereby a Qualified Intermediary holds the replacement property until the relinquished property can be sold.

3. Simultaneous Exchange: A simultaneous buy-sell. These types of exchanges are exceedingly rare.

4. Improvement Exchange – Forward or Reverse: In an Improvement Exchange, sometimes called a Construction Exchange or Build-to-Suit Exchange, an investor invests in the acquired property – which can include repairs, improvements and/ or new construction – using exchange equity. Improvement 1031 Exchanges are used in conjunction with either a Forward Exchange or a Reverse Exchange structure.

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Why do I keep hearing about Delaware Statutory Trusts (DSTs)?

A DST isn’t a type of 1031 exchange, rather it is a vehicle that exchange proceeds can be invested into. DSTs allow investors to exchange relinquished property into units of a trust holding qualifying real estate. Of the 1031 exchanges done today, DSTs are believed to represent approximately 10% of the volume – this share has been increasing over the past decade as investors that "own dirt" seek to transition from active real estate management to passive mailbox money.

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How much time do I have to complete a 1031 exchange?

The IRS has very specific rules governing the timeline of a 1031 tax-deferred exchange. You have 45 days from the close of your first transaction to identify – in writing – your replacement property or properties. You have a further 135 days from there (or 180 days total from the close of your first transaction) to close your second transaction and successfully complete your exchange. These deadlines are firm, regardless of whether the 45th or 180th day falls on a Saturday, Sunday or Holiday.

Can I sign a Purchase & Sale Agreement, then start exploring a 1031 exchange?

Yes. The date a PSA is signed – for either your relinquished property or replacement property – isn’t relevant to your 1031 eligibility. What matters is the date your first transaction closes. Provided you haven’t closed, you still have time to explore a 1031 exchange.

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What happens if I don’t complete my 1031 exchange in time?

If you don’t meet the key 45 and 180-day deadlines required by the IRS, your exchange fails and you will be taxed on any gains from the sale of your property. You can still buy and sell property, you just won’t get the benefit of tax deferral on the transaction. It’ll be like your 1031 exchange never existed.

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How long do I have to own my investment property to qualify for a 1031 exchange?

There is no hard and fast rule as to the length of time a property must be held before being sold – the actual measuring stick used by the IRS is a “reasonable time” – but a general guidepost is two years and one day.

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What types of real estate qualify for a 1031 exchange?

Click here for details.

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Does my Airbnb property qualify for a 1031 exchange?

Yes, subject to certain criteria, short-term rentals qualify under 1031 tax-deferred exchange rules.

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Who qualifies for a 1031 exchange?

1031 exchanges are available to investors, not to people that trade real estate for a living. So long as you aren’t a “flipper” or developer, you will be eligible for a 1031 exchange.

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If I hold a property in a corporate entity, can I still qualify for a 1031 exchange?

Any taxpayer, whether an individual, married couple or entity, can successfully complete a 1031 exchange. Qualifying entities include C-Corporations, S-Corporations, General Partnerships, Limited Partnerships, Limited Liability Companies, Trusts, and any other taxpaying entity that owns qualifying property.

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What is the “same taxpayer requirement”?

1031 rules dictate the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property. This requirement is in place to maintain tax continuity.

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Will a 1031 exchange put me at risk of an IRS audit?

1031 tax-deferred exchanges are a 100% approved method of buying and selling investment property – these rules have existed in the US for more than 100 years. In our experience, as long as a recognized, qualified firm follows U.S. Tax Code, Title 26, Section 1031, and documents everything properly, there is no additional risk of an audit.

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If I did a cost segregation study and benefitted from bonus depreciation on the property I’m selling, can I still do a 1031 exchange?

Yes, you can do both a 1031 exchange and cost segregation / bonus depreciation on the same property. It is imperative that you seek tax counsel to understand the tax implications given your unique circumstances.

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How many times can I do a 1031 exchange in my lifetime?

There is no limit – you just need to follow the rules each and every time.

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What does it mean to “swap ‘till you drop”?

The 1031 grandmasters know a secret: if you keep rolling one 1031 exchange into another until your time on Earth is up, you will not only have deferred taxes on your gains each time, but you will have accomplished the seemingly impossible: avoiding taxes altogether. How is this? Because when your properties pass to your kin, they get a step-up in basis, effectively making a lifetime worth of gains invisible to the US Government.

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If I want to identify more than three replacement properties during my 45-day identification period, what are the additional requirements I must follow?

If you wish to identify more than three replacement properties, you can. However, identifying four or more properties means your exchange must also pass one of these two additional tests:

1. The 200% Rule: the combined fair market value of all your identified replacement properties cannot exceed 200% of the value of your relinquished property.

2. The 95% Rule: you can exceed the 200% rule but you must acquire >=95% of the fair market value of the properties you identify.

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Do I have to exchange into the same property type as the one I’m selling?

No. You aren’t required to exchange one property for exactly the same type of property. You can exchange raw land for a rental home, an apartment complex for a shopping center or rental houses for an office building. You can exchange property in different states. You can diversify by exchanging one property into multiple properties, or you can consolidate your portfolio by exchanging multiple properties into a single property. So long as all property is held for business or investment purposes, you have nearly infinite exchange options.

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How do I calculate net selling price of my relinquished property?

Net Selling Price = (Contract Sale Price) – (Realtor Commissions) – (Title Fees) – (Other Allowable Expenses)

“Other Allowable Expenses” include usual and customary expenses incurred during a transaction including 1031 Exchange Fees, Recording Fees, Transfer Taxes, Appraisal Fees, Termite Inspection Fees, Wire Fees, and Courier Fees.

Property taxes, lender fees, and HOA / condo fees are not included in the Net Selling Price calculation.

You can download our detailed worksheet here to understand the math behind your 1031 exchange.

When do I report the exchange to the IRS?

Exchanges are reported to the IRS for the tax year in which the first relinquished property is transferred, even if the replacement property(ies) are transferred in the following tax year. For example, if you close on your relinquished property in December and settle on your replacement property in May of the following year, you will file an extension by mid-April and then file IRS Form 8824 once your replacement property is received.

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What are the benefits of a 1031 exchange?

1031 exchanges offer you the ability to defer – and even eliminate – real estate taxes and maximize real estate gains. They are a cheat code to building wealth.

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What is a Qualified Intermediary (QI)?

A Qualified Intermediary is a non-biased third party that facilitates 1031 exchange transactions.

Why do I need a Qualified Intermediary?

IRS rules require a Qualified Intermediary to facilitate a 1031 exchange. Without one, you can’t qualify for a 1031 tax-deferred exchange.

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What is the role of a Qualified Intermediary?

A Qualified Intermediary has three primary duties:

1. To provide consultation on your 1031 exchange.

2. To secure your funds during the duration of the exchange.

3. To prepare the necessary exchange documentation and coordinate with your closing agents to properly transfer the relinquished and replacement properties according to Regulations Section 1.1031.

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I’m a visual learner… can you show me how a Qualified Intermediary fits into my 1031 exchange transaction?

Qualified Intermediary plays a central role in a 1031 exchange transaction. Here’s how it looks visually:

Can I be my own Qualified Intermediary?

No.

Can my real estate agent be my Qualified Intermediary?

No. Your QI may not be your agent or fiduciary.

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When do I need to hire a Qualified Intermediary?

If you do not have a Qualified Intermediary in place before the close of your first transaction, the opportunity to do a 1031 exchange is lost.

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Why does a Qualified Intermediary control my sale proceeds?

A key requirement of a successful 1031 exchange is that the investor selling the investment property must avoid constructive receipt of the proceeds from the sale. If you have the ability to access, control or receive, or could have received, the proceeds from your sale, the IRS will disqualify your 1031 exchange.

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When are funds released from the trust account that holds my sale proceeds?

In the event of a successful 1031 exchange, funds are released at close per your closing instructions. In the event of a failed exchange, IRS regulations prevent the early release of funds. If your exchange were to fail, you’ll either receive your money back shortly after the 45th day or the 180th day:

- If you fail to identify replacement property 45 days following the close of your first transaction, your exchange will fail and your proceeds will be released to you the next business day following the 45-day identification period.

- If replacement property was identified but you do not acquire replacement property, your exchange will fail and your proceeds will be released the next business day following the 180-day exchange period.

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What are your fees?

The prices of our services are listed here. There are no hidden fees.

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When do I get charged?

We invoice clients at the close of the first transaction.

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If I sign up but change my mind, do I still get charged?

Our services are offered with a "pay us when you close" guarantee – if you decide not to go through with your exchange for any reason, we’ll send your fee back to you.

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When should I reach out to 1031 Specialists about my exchange?

Ideally, you will engage us during the evaluation stage of your first transaction, just prior to signing your Purchase & Sale agreement. If you’ve already signed your PSA, no worries – we can still help make your 1031 exchange happen.

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How long does it take 1031 Specialists to complete its work?

For Forward exchanges, exchange documentation and closing instructions are typically turned around 24 hours after receiving all required information. Reverse and Improvement Exchanges are significantly more complex and take two to three weeks to complete.

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What’s a standard 1031 process look like?

The steps of a standard Forward exchange are described here.

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Why should I choose 1031 Specialists as my Qualified Intermediary?

So many reasons – see some of them here.

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Does 1031 Specialists hold my sale proceeds?

No, we do not hold a client’s exchange money. We partner with FDIC-insured banks who open an individual, segregated trust account for you. The account is set up in your name and no 1031 funds move in or out of the account without your written and verbal authorization.

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How do you protect my money?

Great question. See here.

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Who are the folks behind 1031 Specialists?

Meet us here.

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FAQs

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