What Is A 1031 Tax Exchange

Keys in the shape of 1031 to depict a 1031 tax exchange

A 1031 allows you to avoid paying capital gains when you sell an investment property and reinvest the proceeds from the sale into another property or properties of equal to or greater than value, within certain time limits. The 1031 Tax Exchange allows you to defer the tax on the appreciation to a later date. If you were to simply sell your current investment property and buy another updated, upgraded, more expensive property, next year come tax time you will owe capital gains. This could be as much as 20% on the appreciation and profits on the property since you owned it. Please note this explanation is from a real estate agent.  I am not a CPA or an accountant.  This explanation is an example and highlights what could happen.  If you instead do a 1031 tax exchange when you sell the property you will not owe capital gains taxes.

How does a 1031 tax exchange work? 

What is the process?  If you were to participate in a 1031 tax exchange the process would be as follows. You list the property that you currently own for sale.  We will call that property your relinquished property.  You accept a contract to purchase and go through the process to sell your relinquished property just like you would if you were not doing a 1031.  Here is what is different and keeps you from paying taxes.  Once the relinquished property is listed for sale you contact an exchange company.  Ask you real estate agent for recommendations. The exchange prepares documents that must be signed, prior to and at the closing. The exchange company charges a fee for their services. 

How Does Closing Work?

The closing occurs and the exchange company takes the proceeds from the relinquished property closing and holds the proceeds from that sale until the closing on the replacement property that you are in purchasing.  After the closing on the relinquished property you will attend the closing of your more expensive property.  You attend the closing with your ID and a smile on your face.  In advance of the closing, the exchange company wired the funds from the sale of your relinquished property to the title company.  You sign the documents for the closing and you are handed the keys.  You have just participated in a 1031 tax exchange. This is a simplistic description of the process.  Moreover, there are very specific rules that must be followed for a 1031 exchange to be successful.  Timing is very important.

If you are interested in learning more about a 1031 and how you might benefit from participating in one you should consult a CPA that can walk you through the details.  If you decide to do a 1031 tax exchange contact us to make sure you work with a real estate agent that is familiar with 1031 so that you can successfully complete an exchange.