A 1031 exchange is an incredibly powerful tool that allows an individual to save on taxes after the sale of a piece of real estate. This tax deferral program permits the investor to sell a real estate property and then reinvest the funds in a property of equal or greater value. Doing so allows the investor to keep more money in their pocket, and defer all capital gains taxes.
However, the IRS' guidelines on conducting a 1031 exchange are stringent. Here are six rules that an investor must follow:
- In a 1031 exchange, the properties involved must be held for either business or investment purchases. You cannot conduct a 1031 exchange on your primary residence.
- The IRS requires that the investor identify their purchasing plans on day 45. The investor must describe the property or properties they are planning to use as the replacement in the exchange.
- The IRS also has a strict timeline that the investor must uphold. The investor has 180 days to complete the exchange. This begins on the day escrow closes on the sale.
- The investor must also work with a qualified intermediary. This is a third party that holds the money for the exchange in escrow.
- The title on the new purchase must be identical to the old property. For example, if first property was held in an individual’s name, that person cannot put the new purchase in their LLC.
- A 1031 exchange permits the investor to sell a real estate property and then reinvest the funds in a property of equal or greater value. The investor cannot make a purchase for less than the original property. This would defeat the purpose of deferring taxes on a gain.