A 1031 exchange is a real estate investing tool that allows investors to swap out an investment property for another and defer capital gains tax that you otherwise would have to pay at the time of sale. This is a popular tax tool used by investors looking to upgrade or reinvest capital gains without being taxed at the time of sale.
The initial step is to determine the property you want to sell and the property to exchange. A replacement property must be identified within 45 days of the sale, and you must close on the replacement property within 180 days. These time periods run concurrently, meaning the “start date” for both time periods starts the day the old property is sold. The property you’re selling and the property you’re buying must be “like-kind,” which means they must be similar but not necessarily the same quality or grade.
As an Exchangor, you are required to provide in writing an “unambiguous description” of the potential replacement property prior to midnight on the 45th day after the close of relinquished property. A legal description or property address will suffice. If you wish to identify or purchase multiple properties, you must follow one of the following guidelines:
Then, you must work with a qualified intermediary, also known as an exchange facilitator, to handle a 1031 exchange transaction. The qualified intermediary holds your funds in escrow for you until the exchange is complete. They are essentially an IRS required middle-man.
Lastly, you’ll need to tell the IRS about your transaction through IRS Form 8824 with your tax return. On that form, you’ll describe the properties, provide a timeline, explain who was involved in the process and list the money involved.