An Introduction to 1031 Exchanges for Real Estate Investors
Real estate investors may look for ways to manage their tax exposure when selling investment properties.
One option available under the U.S. tax code is the 1031 exchange—a provision that allows for the deferral of capital gains taxes when certain conditions are met.1
While our company does not offer tax or investment advice, we believe it's important for our investor clients to understand this provision and how it may intersect with mortgage financing decisions. For advice about 1031 exchanges, consult a licensed tax professional.
Understanding 1031 Exchanges1
A 1031 exchange refers to Section 1031 of the Internal Revenue Code, which permits the exchange of one investment or business-use property for another of “like-kind” without immediate recognition of capital gains. This means that, under qualifying conditions, the investor can defer paying taxes on the gain until a future taxable event occurs.
What Counts as “Like-Kind” Property?1
The IRS defines like-kind real estate broadly. Properties are considered like-kind if they are of the same nature or character—even if they differ in grade or quality. For example:
- A rental condo may be exchanged for a commercial building.
- Vacant land may be exchanged for improved property.
However, U.S. real estate cannot be exchanged for foreign real estate, and personal-use property (like a primary residence) does not qualify.
Crucial Timing Rules2
Timing is critical in a 1031 exchange. The IRS enforces two strict deadlines:
- 45-Day Identification Period: The seller must identify potential replacement properties within 45 calendar days of selling the original property.
- 180-Day Completion Period: The entire exchange must be completed within 180 days of the sale.
These deadlines are firm, and extensions are rarely granted.
The Role of a Qualified Intermediary2
To comply with IRS rules, the investor cannot take possession of the sale proceeds. Instead, a third-party professional known as a Qualified Intermediary holds the funds and facilitates the exchange. If the investor receives the funds directly, even temporarily, the transaction may be disqualified and taxed as a sale.
What Doesn’t Qualify?1
Not all property types or transactions are eligible for 1031 treatment. Common exclusions include:
- Personal residences
- Property held primarily for resale (inventory)
- Stocks, bonds and partnership interests
- Foreign real estate
- Equipment, artwork, and other personal property
These exclusions are outlined in IRS regulations and reinforced by court rulings.
Reporting the Exchange
Investors must report a 1031 exchange using IRS Form 8824, which details the properties involved, timelines and any gain or loss. Accurate documentation is essential, and many investors work with tax professionals or legal advisors to ensure compliance.
Final Thoughts
For detailed information about 1031 exchanges, contact a licensed tax professional.
If you are in need of a mortgage product tailored to your goals as a real estate investor, we have solutions for you. Give us a call for more information.
Sources:
1 Like-kind exchanges - Real estate tax tips | Internal Revenue Service