If you're investing in real estate—or thinking about it—you may have come across the term "1031 exchange." This IRS provision can impact how capital gains taxes from property sales are handled, and is used by many investors to grow their portfolios.
At Newrez, we work with a wide range of borrowers, including residential real estate investors. While we don’t offer tax or investment advice, we want to equip our investor borrowers with a basic understanding of this tax strategy. For personalized guidance, be sure to consult a qualified tax advisor.
Are you a real estate investor looking for mortgage solutions? Reach out to a Newrez mortgage expert today to learn how we can support your goals.
What Is a 1031 Exchange?1
A 1031 exchange is a tax provision that lets individuals sell one investment property and reinvest in another without immediately paying capital gains taxes on the sale. As long as both properties are used for business or investment purposes and meet the IRS’s “like-kind” criteria, the investor can defer paying taxes until a later sale.
How 1031 Exchanges Work
- Nonrecognition of gain or loss1: When a valid 1031 exchange occurs, the IRS allows investors to defer capital gains taxes on the part of the transaction that involves like-kind properties. This means the gain isn’t taxed at the time of the exchange, nor is a loss recognized.
- Real property only1: Since 2018, Section 1031 applies only to exchanges of real property; personal property and most intangible property no longer qualify for like-kind exchange treatment.
- Not a tax elimination2: The provision defers tax “indefinitely” but does not permanently eliminate it. Deferred tax can become payable later when a taxpayer sells without using another qualifying exchange.
Like-Kind Property: What “Like-Kind” Means
- Broadly applicable to U.S. real estate1: For real property held for business purposes, the IRS treats most real estate as like-kind to other real estate, regardless of grade or quality (for example, rental properties can be like-kind to vacant land).
- Use requirement1: Both the sold property and the replacement property must be held for use in a trade or business or for investment—it cannot be held primarily for sale.
Key Timing and Procedural Rules2
- 45-Day Identification Period: From the date the property is transferred to new ownership, the investor has 45 calendar days to identify potential replacement property(ies) in writing under the IRS rules.
- 180-Day Exchange Period: The exchange must be completed within 180 calendar days of the original sale date.
- Qualified Intermediary (QI): In a 1031 exchange, the seller can’t receive the sale proceeds directly—doing so would trigger taxes and disqualify the exchange. Instead, a third-party professional known as a Qualified Intermediary holds the funds and manages the transaction to keep it compliant with IRS rules.
Common 1031 Exchange Structures2
- Delayed (deferred) exchange: The seller transfers the relinquished property first, identifying a replacement property within 45 days and closing on the new property within 180 days.
- Simultaneous exchange: The like-kind properties are bought and sold at essentially the same time.
- Delayed reverse exchange: The replacement property is acquired before the relinquished property is transferred.
- Improvement (build-to-suit) exchange: Exchange proceeds are used to construct or improve the replacement property during the exchange period.
Reporting and Documentation
- Form 88243: Taxpayers use Form 8824, Like-Kind Exchanges, to report a 1031 exchange to the IRS and to show calculations that support any deferred gain or recognized gain.
Limitations and Reminders
- Not all transactions qualify1: Personal residences, property held primarily for sale, and most personal or intangible property do not qualify for Section 1031 treatment.
- Partial recognition1: If the seller receives cash or not like-kind property as part of the exchange, gain must be recognized.
- Strict deadlines and rules2: Missing identification or closing deadlines, improperly accessing proceeds, or mischaracterizing the use of a property can disqualify the exchange.
Speak With a Licensed Professional
If you want to learn more about 1031 exchanges and whether they might benefit your investment strategy, reach out to a tax professional.
Mortgages for Real Estate Investors
Newrez carries mortgages that allow you to use rental income (cash flow) to qualify for a loan. Learn more in this article. If you have questions, our mortgage experts are happy to walk you through your options.
References:
1 Like-kind exchanges - Real estate tax tips | Internal Revenue Service
2 The 1031 Exchange Rules You Need to Know | Kiplinger
3 About Form 8824, Like-Kind Exchanges | Internal Revenue Service
