If you own an investment property and are considering selling it, engaging in a 1031 “like-kind” exchange might be a smart move. When done correctly, a 1031 exchange will allow you to defer all or part of the capital gains and deprecation recapture tax you would otherwise need to pay upon the sale of your property. The transaction isn’t tax-free, it is tax-deferred, pushing the tax liability into the future or onto your heirs. Real estate must be replaced with like-kind real estate and there are many property types that do not qualify (i.e. personal residence, property purchased for resale/flips, partnership interests, etc.).

Assemble a Team of Experts

The first step is to choose a reputable Qualified Intermediary. This person is responsible for preparing and managing any important documents that apply to the relinquished and replacement properties, as well as ensuring you comply with the necessary regulations. The QI also serves as the custodian for the sales proceeds and holds the funds until you’re ready to complete the exchange.

In addition to your QI and investment professional, others you may want on this team include a real estate agent, lawyer, and accountant. Take your time to confirm that each person you choose is intimately familiar with 1031 exchanges.

Understand all Critical Timelines and Deadlines

If you fail to meet any necessary deadlines, your exchange will fail and you will lose all the tax advantages. First, you have 45 days from the day you sell to identify your replacement property. You then have a subsequent 135 days to close on those properties, totaling 180 to complete the entire exchange.

Learn the Basics of Property Selection

IRS rules allow investors to choose from one of three identification rules. You can either,

  1. Identify up to three replacement properties and close on any number of them;
  2. You can identify more than the three individual properties, as long as the total value doesn’t exceed 200% of the value of your relinquished property sale;
  3. In some special cases, you can identify an unlimited number and value of properties, so long as you close on at least 95% or more of those identified properties.

These rules can be tricky and lead to a failed exchange if not done properly. It’s best to consult your team to ensure you’re making a suitable choice.

Always Have a Backup Plan

If anything goes wrong with your property purchase, your 1031 exchange could fail. For this reason, it is a good idea to identify more than one replacement property. Even if you think you know which property you want to purchase, it’s crucial to have a “backup plan” in place.