1031 Exchange
Explained

Basic Guidelines

Strict compliance with IRS guidelines is essential for a successful 1031 exchange. Investors should understand the four fundamental requirements of a delayed exchange and consult their tax advisor or attorney to ensure proper adherence to the tax code.

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1. Property Qualifications

The Internal Revenue Code requires that both the relinquished and replacement properties be held for investment or productive use in a trade or business and be “like-kind.” All U.S. real estate is considered like-kind to other U.S. real estate, regardless of type (e.g., a rental home for a four-plex, or a warehouse for an office interest). However, foreign property is not like-kind to U.S. property.
 

Dealer property, real estate held primarily for resale or as inventory, does not qualify. The IRS focuses on the investor’s intent at the time of acquisition to determine eligibility.

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2. Timeline

A 1031 exchange must be completed within 180 days of the sale (close of escrow) of the relinquished property. In addition:
 

• All potential replacement properties must be identified in writing by midnight on day 45.

• The replacement property must be acquired by midnight on day 180.
  No extensions or exceptions are allowed. Failure to meet either deadline disqualifies the exchange.

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3. Identification Rules

Replacement properties must be clearly identified in writing by day 45. The IRS allows two identification options and one 'exception':
 

• The Three-Property Rule: Identify up to three properties, regardless of value.

• The 200% Rule: Identify any number of properties, provided their total fair market value does not exceed 200% of the value of the relinquished property.  Example: If a property sells for $500,000, the investor may identify multiple properties totaling up to $1,000,000.

• The 95% Exception: You may identify any number of properties of any value, as long as you acquire at least 95% of the total identified value within 180 days. This exception is rarely used. 

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4. Reinvestment Requirement

To achieve full tax deferral, the investor must:
 

1. Reinvest all net proceeds from the sale, and

2. Acquire property of equal or greater value than the relinquished property.

Partial exchanges—where the replacement property is of lesser value—are permitted but result in partial tax liability.
 

Example: Selling a $500,000 property with $200,000 equity and purchasing two $300,000 properties (using $100,000 down each) achieves full deferral. Buying for $400,000 instead would trigger taxes on the $100,000 difference.