1031 exchange - What is it?

In looking through online MLS websites, I have seen the comment “1031 exchange” many times. Can someone enlighten me on what exactly that means?


This link should help…


A simple 1031 is a way to defer paying tax on profits (gain)
of income real estate (and sometimes other gain as well).
A great thing but ALWAYS talk to a tax advisor BEFORE starting one.
Mistakes are costly.

Costs run under a $1000.

Good luck,

A 1031 exchange is free money from Uncle Sam.

I always assumed it was an even exchange for another property… for those who didn’t want to sell theirs and pay taxes if moving or buying a different piece of propterty.

After reading your link it sounds as if i could sell one of my rentals/leaseoptions but buy 1-3 more properties for no more than 2x the fair market value of the other property. As long as i do not put the funds in my bank account after the sale i have a few months to buy more property but not pay anything for the gain on the previous house?

Please help lay it out more easily for me, can these 3 be from multiple sources? how is the income viewed by value difference upon the sale of 1 of the 3 later down the road… more info please :slight_smile:

It is a way to shelter taxes. If you sell a property a 1031 allows you to reinvest the profits within a certain time frame. The only problem is you have to invest in a property of equal or greater value.

What is a 1031 exchange?

Under section 1031 of the Internal Revenue Code, a real property owner can sell his property and then reinvest the proceeds in ownership of like-kind property and defer the capital gains taxes. To qualify as a like-kind exchange, property exchanges must be done in accordance with the rules set forth in the tax code and in the treasury regulations. The 1031 exchange can offer significant tax advantages to real estate buyers. Often overlooked, a 1031 exchange is considered one of the best-kept secrets in the Internal Revenue Code.

Who should consider a 1031 exchange?

If you have real property that will net you a gain upon sale (generally property that has been substantially depreciated for tax purposes and/or has appreciated in fair market value), then you are exactly the person who should consider a 1031 exchange.

There are 5 tax classes of property:

  1. Property used in taxpayer’s trade or business.
  2. Property held primarily for sale to customers.
  3. Property which is used as your principal residence.
  4. Property held for investment.
  5. Property used as a vacation home.

Section 1031 applies to the first and fourth categories, and potentially the fifth category. Business use is defined as, “To hold property for productive use in trade or business.”

Property retired from previous productive use in business can be qualifying property. Investment purpose defined as real estate, even if unproductive, held by a non-dealer for future use or increment in value is held for investment and not primarily for sale.

Investment is the passive holding of property, for more than a temporary period, with the expectation that it will appreciate. Property held for sale in the immediate future is not held for investment.

Why should you consider a 1031 exchange?

-Defer paying capital gains taxes.


-A properly structured exchange can provide real estate investors with the opportunity to defer all of their capital gains taxes. By exchanging, the investor essentially receives an interest-free, no-term loan from the government.

-Relief from property management. The lessee takes the responsibility to sublet and maintain the property allowing real estate buyers to avoid most of the day-to-day management headaches.

-Upgrade or consolidate property.

-Diversify. Own multiple properties rather than just one.

-Relocation to a new area.

-Differences in regional growth or income potential.

-Change property types among residential, commercial, retail, etc.

To Get all The Details on 1031 Exchanges go to:

REALTOR.org has launched an updated guide to 1031, or tax-deferred, exchanges. This guide provides access to articles, manuals, forms, and ideas to help members start building their 1031investment property niche.

Link: http://www.REALTOR.org/libweb.nsf/pages/fg105


I hope this helps.


Since Uncle Sam is not really giving you any money, maybe we should think of a 1031 exchange as a device which keeps Uncle Sam from taking a share of your profits until the replacement property is sold in a taxable sale.

Thank you all of explaining 1031 exchange!
On this website I read that one has 180 days to exchange the property and one " must identify property in a written document signed by you, and delivered to the party assisting you with the exchange (cannot be related to you!) on or before 45 days from the date you sold the original rental property." (David Whisnant’s article on 1031 exchanges)
Question: who is this mysterious party assisting w/ the exchange? Why do I need to notify them? Do I need them if I close within 45 days? Does 200% rule apply to properties closed within 45 days? Who should I tell that this is a 1031 exchange and why would they care?


These days, when we discuss 1031 exchanges, we are generally referring to a forward exchange, sometimes called a delayed exchange. Since the seller of your replacement property and the buyer of your relinquished property are separate individuals (or entities), a qualified intermediary is needed to hold the exchange funds out of your constructive receipt. This qualified intermediary is the mysterious party who will establish an escrow account for your exchange funds as well as receive and disburse title unless you are direct deeding.

You need to have an exchange agreement in place with your qualified intermediary, and the buyer of yourr relinquished property must also cooperate by signing whatever documents may be required for your relinquished property to participate in the exchange.

After the settlement on the relinquished property, you have 45 days to identify your replacement property in writing to your qualified intermediary. It is the qualfied intermediary who will disburse the exchange funds to your settlement agent when you acquire your replacement property. Failure to use a qualified intermediary in a forward exchange voids the exchange and the relinquished property sale becomes a taxable event.

Up to three properties can be identified as potential replacement properties without regard to dollar value. If more than three properties are identified, then the total value of all identified properties can not exceed 200% of the relinquished property value. If you acquire your replacement property within 45 days of the relinquished property sale, you can skip the property identification step in the exchange procedures.

Just my understanding of the 1031 exchange rules. I’ve only opened escrow on my third exchange, so I might not have it all down pat yet.

Dave T,
Thanks for you constructive answer.
I want to sell the rental house that I own and buy two other properties almost simultaneously or within a short time period. The IRS Code doesn’t say anything about a Qualifited Agent and does not require one. So, doesn’t selling one house and buying 2 other houses instead qualify as a 1031 exchange? Why do I need someone to hold my funds? I’m not sure I understand the logic here…

the key phase is “you can not take conscriptive receipt of the proceeds of the sale”. You MUST use an accomadator from this transaction. Many Title companies (e.g Fidelity) can do this. Timcor, Inc was doing this but they just got bought (I forget by who).

Note, it can not be your principle residence. It must be an investment property.

Thank you for your answer!
I’m still a little confused here - what does an Qualified Intermediary have to do with an IRS rule. Basically, I bought a house in AZ as I was being transferred there for work. I transferred and now I’m being transferred again to another state. I want to sell this house and buy two rental properties instead. Wouldn’t I qualify for the 1031 exchange? It’s an in-kind exchange as far as they’re concerned, isn’t it? When I buy the other two properties I will tell the lender that they are for investment purposes, but they shouldn’t care where the downpayment for them comes from-it’s strictly between me and the IRS. Please explain!
Thank you very much!

If you are selling your primary residence, Section 121 of the tax code applies. If you meet the ownership and occupancy requirements, up to $250K of your sale profit (per taxpayer) is tax free. You are free to reinvest your sale proceeds any way you wish with no adverse tax consequences.

Section 1031 of the tax code only applies to investment property or property used in yourr business. Investment property is not held primarily for personal use like your primary residence or second home. Instead, it is property held for the production of income or for future appreciation. The tax code does not use the term “in-kind” exchange. The code permits “like-kind” properties to participate in an exchange. Since an exchange is limited to investment use or business use property, the replacement property must also be investment use or business use property to be “like-kind”.

Section 1031 of the tax code allows a forward exchange but prohibits constructive receipt of the proceeds from your relinquished property sale. Someone else has to act as your exchange agent – a qualified intermediary. The IRS has restrictions on who may act as your QI. As originally envisioned, the QI would be assigned the deed and sale contract on your relinquished property, then transfer the deed to your buyer while received the net sale proceeds. The QI would then apply the sale proceeds to the purchase of your replacement property and convey the deed to you. Somewhere along the line, someone decided that all the QI really had to do is hold your exchange funds outside of your constructive receipt, so you are permitted to directly deed your relinquished property to your buyer and receive deed to your replacement propery from the seller.

If you are still confused on this topic, you might try putting “1031 exchange” in your Google search engine. From the hits, I am sure you will find a lot of detailed information that will address almost any 1031 exchange question you may still have.

Dear Dave T,
Thanks so much for your answers!
I have yet another question regariding this issue. How can I avoid Sec 121? Can I rent the house for sometime, treat it as a rental property and then exchange it? Will the fact that this was purchased as a primary residence (which I lived in for a few months) somehow come up during the exchange process? Will QI intermediary know that this house was originally purchased as a primary residence and then rented out? Don’t get me wrong, I’m not trying brake any laws - I’m just looking for ways to legally go about this issue.
Please advise.
Thank you.

Section 121 is best for you if you meet the two year ownership and occupancy requirements to take all your sale profit tax free. If you fail to meet the two year requirements a tax free “reduced maximum exclusion” is also available if you meet certain hardship requirements. The Section 121 capital gains exclusion is available to you but you are not required to use it if you don’t want to.

Only if you fail to satisfy any of the requirements you need to meet to take your sale profit tax free, do you want to consider converting your primary residence to an investment rental. Using the property as an investment rental for a period of time (I suggest one year), will make the property eligible to participate in a 1031 exchange.

The QI won’t care that the property was your former primary residence, only that the property is currently qualified exchange property and that your replacement property is “like-kind” property.

Dave T,
thanks a lot for taking time to answer my questions!
How do I convert the my primary property into a rental property? Do I just start renting it out? Any paperwork that need to filled out?
Thanks again.

Just move out and start advertising for renters.

Dave T,
sorry for such an overwhelming amount of questions
What about the liability protection then? I can’t put a primary residence into an LLC w/o triggering the DOS clause. What type of insurance should I get? For how much?
Thanks again!

I am not sure you would want to put your primary residence into an LLC.

I believe the $250K/$500K capital gains exclusion is only available to individuals. It is not clear to me that you would still retain the exclusion if your LLC owns your primary residence. Not sure on this point, but it is something to check.

You conduct all your business activity from within your LLC to shield your personal assets from exposure to a lawsuit arising out of your business activities. The LLC “limits” your liability to only the assets owned by the LLC – hence the name, Limited Liability Company. Putting your personal residence into your LLC removes your home from the liability shield provided by your LLC.

If you are sued personally over something that happens in your home, your homeowner’s insurance carrier will defend you in the lawsuit and pay any judgement award up to your limit of coverage, provided they were not able to reach an out of court settlement.

These are all legal questions to address with your attorney. I am not an attorney, nor a CPA. My responses are provided for educational purposes only and are not to be construed as either legal or tax advice.