What is a 1031 exchange?

A 1031 exchange, also known as a like-kind exchange, allows you to swap one investment property for another without paying immediate taxes. This process lets you defer or avoid taxes by continuing to reinvest in new properties, with only one tax due at the final sale, at the long-term capital gains rate (0% to 20%, depending on income).

The properties exchanged must be like-kind, meaning they are of similar nature or character, though this can include a variety of asset types. You can exchange properties such as apartment buildings for raw land or businesses for other businesses. While 1031 exchanges generally apply to investment and business properties, there are specific rules for former primary residences and vacation homes.

Key Takeaways

• A 1031 exchange allows deferring capital gains tax by swapping a business or investment property for a new, similar property.
• Proceeds from the sale must be held in escrow by a third party and used to purchase the new property; you cannot receive them, even temporarily.
• The properties exchanged must be considered like-kind by the IRS for tax deferral.
• You can perform 1031 exchanges as frequently as you wish, provided the rules are followed.
• The rules can apply to a former principal residence under specific conditions.

Replacement Property Identification Rules 

1. 45-Day Identification Window: You have 45 days from closing on the sale of the relinquished property to identify potential replacement properties.
2. Three-Property Rule: You can identify up to three properties regardless of their total value.
3. 200% Rule: You can identify any number of properties as long as the total fair market value doesn’t exceed 200% of the fair market value of all relinquished properties.
4. 95% Rule: If you identify more than three potential replacement properties and the total value exceeds 200%, you must acquire properties valued at 95% of the value of all identified properties.

Please ensure you adhere to these rules to maintain the tax-deferred status of your exchange. Contact your exchange facilitator or tax advisor if you have any questions.