What Is the 1031 Exchange?

Perhaps you’ve heard of the 1031 Exchange. Perhaps you haven’t. Regardless, you are likely unfamiliar with what a 1031 Exchange actually does and how it works. The 1031 Exchange is a federal tax-deferral option popular among real estate investors. Section 1031 of the Tax Code allows investors to swap like-kind assets without incurring taxes, which makes it a powerful investment tool for building wealth. The 1031 Exchange is also referred to as a “like-kind” or “Starker” exchange.

Consider a scenario where a real estate investor owns a property worth $500,000 and will owe $100,000 in capital gains taxes. The investor would like to acquire a different property of similar value (a “like-kind” property). If selling the property and paying capital gains, the investor will be left with $400,000 in cash to put towards the next property. The 1031 allows the investor to defer these capital gains. If the investor were to use a 1031 Exchange, then all $500,000 of the property’s value would be available for the next property as the $100,000 of capital gains are deferred.

It’s important to note that the 1031 exchange does not eliminate an investor’s requirement to pay capital gains taxes; rather, it delays it. Thus, when an investor acquires a new property through a 1031 Exchange, the tax basis of the new property is adjusted to reflect the delayed capital gains. This capital gains delay allows investors to put more money forward to build wealth, which ultimately produces greater long-term returns. 

Conducting a 1031 Exchange

There are four methods of conducting a 1031 exchange:

  • Simultaneous Exchange: this exchange occurs when two parties exchange properties at the same time. A simultaneous exchange is rare as finding a like-kind property with a seller who is similarly interested in your property.

  • Delayed Exchange: this exchange occurs when one party sells or “relinquishes” his or her property before identifying a replacement property for the exchange. An investor has 45 days to identify a replacement property from the date of relinquishment and 180 to close the acquisition of the replacement property.

  • Reverse/Forward Exchange: a reverse exchange is the inverse of a delayed exchange. Here, the investor identifies and acquires a property before relinquishing an owned property.

  • Construction/Improvement Exchange: this exchange allows investors to use the tax-deferred dollars to build or improve the replacement property in a 1031 exchange. 

Contact the Law Offices of Richard Palumbo Today 

While a simultaneous exchange does not legally require an intermediary, retaining the services of a real estate attorney experienced in 1031 exchanges is highly advised. Other exchange methods, such as the delayed exchange, require the use of a qualified intermediary. At PALUMBO LAW, we have successfully represented real estate investors in 1031 exchanges across Rhode Island. With more than 100 cumulative years of experience, our attorneys provide exceptional value to real estate investors big and small. If you are considering a 1031 Exchange, or have questions relating to the 1031 Exchange, please contact our office to set up a consultation or complete the contact form.