IR
Licensing Investing Financing Calculators
Tax Strategy

The Section 1031 Exchange

Section 1031 of the IRC allows investors to defer paying capital gains taxes on an investment property when it is sold, as long as another "like-kind property" is purchased with the profit gained by the sale of the first property.

The Absolute Rules of a 1031

A 1031 exchange is strictly monitored by the IRS. Violating a single timeline or rule disqualifies the exchange, triggering immediate capital gains tax and depreciation recapture.

  1. Like-Kind Property: Both the relinquished property and the replacement property must be held for productive use in a trade or business or for investment. (You cannot exchange a primary residence).
  2. Equal or Greater Value: To completely defer tax, the replacement property must be of equal or greater value to the relinquished property, and all equity must be reinvested.
  3. The Qualified Intermediary (QI): You cannot touch the money. A neutral third-party QI must hold the proceeds from the sale and wire them directly to the title company for the new purchase.

The Strict Timelines

The clock starts ticking the day you close on the sale of your relinquished property (Day 0).

Day 45: Identification Period

You must identify potential replacement properties in writing to the QI by midnight of the 45th day. No exceptions for weekends or holidays.

Day 180: Closing Period

You must close on the replacement property (or properties) by the 180th day. This runs concurrently with the 45-day period.

Identification Rules

When identifying properties by Day 45, you must use one of three rules:

  • The 3-Property Rule: Identify up to three properties of any value. (Most common).
  • The 200% Rule: Identify unlimited properties, as long as their aggregate fair market value does not exceed 200% of the value of the relinquished property.
  • The 95% Rule: Identify unlimited properties of any value, but you must actually acquire and close on 95% of the total value identified.

What is "Boot"?

If you trade down in value, or don't reinvest all your cash equity, the difference is called "boot." Boot is taxable. For example, if you sell a property for $500k with $200k in equity, and buy a replacement for $450k putting down $150k, you have $50k of "cash boot" and $50k of "mortgage boot" which will be taxed.