A 1031 exchange is a powerful tool that allows investors to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a similar property.
The process may seem daunting at first, but we’re here to help you every step of the way. In this blog post, we will walk you through the 1031 exchange process from start to finish so that you can confidently take advantage of this powerful tax-deferral strategy.
1. Determine Eligibility
The first step is to determine whether your property is eligible for a 1031 exchange. In order to qualify, the property must be held for investment or business purposes; it cannot be used for personal use. Additionally, the property must be exchanged “like-kind” for another property of equal or greater value.
2. Find a Qualified Intermediary
Once you have determined that your property is eligible for a 1031 exchange, you will need to find a qualified intermediary (QI) to facilitate the transaction. A QI is a third party who holds the proceeds from the sale of your property and then uses those funds to purchase the replacement property on your behalf.
It’s important to note that you cannot complete a 1031 exchange without using a QI—the IRS strictly prohibits it. Furthermore, you cannot use a related party as your QI; the QI must be completely impartial in order to avoid running afoul of the IRS rules.
At Metric, we have our own team of experienced QIs who would be more than happy to assist you with your 1031 exchange.
3. Identify Potential Replacement Properties
Once you have lined up a QI, it’s time to start identifying potential replacement properties. You will need to identify these properties within 45 days of selling your original investment property—and you must do so in writing. The good news is that you are not limited to just one replacement property; you can identify multiple properties, as long as their total value does not exceed 200% of the original property’s value (or 300% if at least 95% of the identified properties are ultimately purchased).
4. Complete the Purchase
Once you have found a replacement property (or properties) that meets your needs, it’s time to complete the purchase—but there are a few things you need to keep in mind first. First and foremost, you must close on your replacement property within 180 days of selling your original investment property (or before your tax return filing deadline, whichever comes first). Additionally, all funds must flow through your QI in order for the exchange to remain valid—you cannot receive any cash back as part of the deal.
If all goes according to plan and everything is done correctly, congratulations! You have successfully completed a 1031 exchange and deferred paying capital gains taxes on your investment property sale.
A 1031 exchange can be an excellent way to defer paying capital gains taxes on an investment property sale—but only if everything is done correctly from start to finish. By working with an experienced qualified intermediary and being mindful of key deadlines throughout the process, you can confidently take advantage of this powerful tax-deferral strategy.