IRS Section 1031 is a code that allows you to swap one of your investment properties for another, as many times as you want, allowing capital gains taxes to be deferred. It is called a 1031 exchange and it is only applicable to investment properties of like-kind. You can do a 1031 exchange on an investment property that used to be your primary residence, but it must be classified as an investment property for at least 1 year at the time of the exchange. In order to qualify for a 1031 exchange, both properties must be located in the United States.
The 45 Day Rule
When you sell your investment property with the intent to do a 1031 exchange, you need to have an intermediary to receive and hold the cash. You cannot receive the cash yourself. Within 45 days of the sale of your investment property, you need to tell the intermediary, in writing, which property you intend to secure. You can actually designate 3 different properties that you are considering.
The 180 Day Rule
Within 180 days of the sale of your investment property, you must close on your new investment property.
What is the point of a 1031 Exchange?
When you sell one property to buy another, you pay capital gains on your sale. A 1031 Exchange essentially allows you to trade one property for another so that you can defer paying capital gains tax, freeing up more money, or capital for you to invest in the new property.
If you end up exchanging your $1 million property for a $600,000 property, you will still owe capital gains taxes on $400,000. If you exchange your property for a property of equal or higher value, you won’t need to pay taxes on the exchange. The 1031 exchange allows you to keep “trading up” to more valuable properties without paying taxes until you decide to sell and cash-out on your retirement.
