What is Section 1031? A 1031 exchange, under IRC Section 1031, is a method for sellers to defer capital gains tax on the sale of a like-kind property, letting them reinvest the full proceeds, trade up or diversity, and adjust real estate holdings as their needs change, without losing hard-earned gains to taxes.
However, 1031 exchanges defer taxes, they don’t eliminate them. Taxes become due if you sell without doing another exchange.
A common myth is that “like-kind” means exchanging the same type of property — such as a single-family home for another single-family home. But, like-kind actually refers to the property’s kind or class. So, land can be exchanged for a rental home is an example.
Most people use a deferred exchange, selling the relinquished property to an unrelated buyer and having the proceeds held by a qualified intermediary (QI) until they’re used to buy one or more replacement properties.
There’s even a structure for a reverse 1031 exchange when the replacement property must close before the relinquished one is sold.
The usual timeline though for 1031 exchanges is 45 days to identify up to three replacement properties once the relinquished property sale closes. Then 180 days to acquire one or more of those three identified properties.
To fully defer taxes, your replacement properties must equal or exceed the value of the one sold. They can be worth less, but there would be tax due on the difference.
Lauren Bunting is a Broker with Keller Williams Realty of Delmarva in Ocean City, Maryland.
