Articles / Tax Deferral & Mitigation Strategies / 1031 Exchange

Taxes are what we refer to as ''guaranteed losses'' and we attempt to defer or eliminate them wherever it is possible. This section covers the primary ways in which an investor can legally defer or mitigate their taxes on income and capital gains.

The 1031 Exchange: A Simple Introduction

The 1031 exchange allows an investor to defer the capital gains taxes that would otherwise be due on the sale of investment property.

In a traditional sale, taxes may exceed 20--30% of capital gains (use our capital gains tax calculator to estimate yours). However if the proceeds from the sale are reinvested according to the rules laid out in IRC §1031, those taxes can be avoided.

To defer the recognition of capital gain, an investor must follow three basic 1031 exchange rules.

1031 Exchange Rule #1
The replacement property must be like-kind to the relinquished property. Generally, real estate held for business or investment purposes in the United States is considered "like kind,” including commercial and residential property.

While residential property held for business or investment purposes qualifies for a like-kind exchange, one’s own residence or vacation home does not. (However there are other tax shelters available for the sale of a personal residence or vacation home.)

1031 Exchange Rule #2
Second, the total value of the replacement property must be equal to or greater than the total value of the relinquished property to fully avoid capital gains taxes. Any capital that is not reinvested is taxable “boot.”

1031 Exchange Rule #3
Lastly, the ownership title for the replacement property must be identical to the title for the relinquished property.

The Stages of a 1031 Exchange

  1. Prior to Start: Plan
    Make plans to carry out a 1031 exchange, and engage a Qualified Intermediary (QI) in advance of the disposition of the property to be replaced.
  2. Day #0: Relinquish
    Sell the investment property to be replaced and have the proceeds held by the QI to avoid taking constructive receipt.
  3. Day #45: Identify
    Work with a broker to identify potential replacement properties within 45 days after sale of relinquished property.
  4. Day #180: Acquire
    Close escrow on replacement property within 180 total days after disposition of the relinquished property.

1031 Exchange Infographic

1031 Exchange Timetable
There are strict time limits for the identification and acquisition of the replacement property. Potential replacement property must be identified by midnight on day #45 after the close of escrow on the relinquished property, and the replacement property must be acquired by midnight of day #180. The day after the close of escrow on the relinquished property is day #1. The exchange period includes weekends and holidays, and there are no exceptions.

You can calculate your 45th and 180th day deadlines
using our 
1031 time limit calculator.

Property Identification Rules
You have your choice between three different rules for identifying and acquiring 1031 replacement properties. You only need to comply with one of these rules. You may identify up to three replacement properties and purchase any, or all, of them, regardless of their total value, to complete your exchange (the “3-Property Rule”).

Or, if you’d rather, you may identify more than three replacement properties, if their total value does not exceed 200% of the total value of the relinquished property. You may purchase as many of the identified properties as you want (the “200% Rule”).

Finally, if neither of the other two rules suit your needs, you may identify any number of replacement properties, regardless of their total value, as long as you acquire 95% of the total value of all of the properties identified (the “95% Rule”).

How to Completely Eliminate Capital Gains
You can continue to defer the recognition of your capital gains using the 1031 exchange until you are ready to pass your investment property on to your heirs. When your beneficiaries inherit your property, its tax basis steps up to the current market value.

If you would like to speak to a knowledgeable
1031 investment advisor who has access to available on- and off-market 1031 investment property, fill out the form to the right.

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