A 1031 exchange lets a real estate investor defer capital gains tax by rolling the proceeds from one investment property into another. The savings can be large, but the whole thing runs on two strict clocks. Miss either one and the exchange fails.
What a 1031 exchange actually does
Named for Section 1031 of the tax code, a like-kind exchange lets you sell investment or business real property and reinvest the proceeds in another like-kind property without recognizing the capital gain right away. The gain is deferred, not erased; it carries into the new property's basis until a future sale, or until the next exchange.
The 45-day clock: identification
From the day you close on the property you are selling (the relinquished property), you have 45 calendar days to identify your replacement property in writing. The identification goes to your qualified intermediary or another party to the exchange. There are limits on how many properties you can name (commonly the three-property rule, or more under the 200 percent rule), and those 45 days include weekends and holidays. There are no extensions for a missed identification.
The 180-day clock: closing
From that same closing date, you have 180 calendar days to close on one of the properties you identified. One catch surprises people: if your tax return for that year is due before the 180 days run out, the deadline becomes the return due date unless you file an extension. The two clocks run at the same time, not back to back, so the 45-day window is part of the 180.
The rules that quietly sink exchanges
- You cannot touch the money. Proceeds must flow through a qualified intermediary. Taking the cash yourself, even briefly, blows the exchange.
- It has to be investment or business property. Your primary residence does not qualify.
- Like-kind is broad for real estate. Most US real property held for investment is like-kind to other such property, but personal property no longer qualifies.
- Trading down creates tax. Cash or debt relief you walk away with (known as boot) is taxable even inside an exchange.