What is a 1031 Exchange?

The 1031 exchange is one of the most widely used pieces of the tax code when it comes to the world of real estate.  Named after section 1031 of the Internal Revenue Code (IRC), the 1031 exchange is one of the most powerful tools available to real estate investors in the US.  Through the use of a 1031 exchange, an investor can essentially defer their capital gains taxes indefinitely (if their strategy is executed properly).  This is possible because the 1031 exchange allows investors to sell an existing property and defer realizing the gains they have on said property so long as the proceeds are rolled into a different investment property.  

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In this guide, we’ll be going through everything you need to know about 1031 exchanges, including their history, how they work, how you can execute a 1031 exchange, and which type of 1031 exchange is right for you!

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The History of the 1031 Exchange

The 1031 exchange was first enacted as a part of the Internal Revenue Code in 1921 as a part of the Revenue Act of 1921.  This means that the 1031 exchange that we know and love today has been around for over 100 years.  The ground-breaking like-kind exchange was introduced by the government to incentivize investors to keep their money invested in real estate by allowing them to defer paying capital gains tax by purchasing another property.  

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However, it was a bit tougher to do a 1031 exchange back then since exchanges often had to be simultaneous. This meant that they were relatively easy to do with personal property.  However, when it came to real estate, they were relatively difficult to pull off.  Fortunately, the 1031 exchange, as we know it, came around in 1978 when the IRC was changed to make 1031 exchanges easier to do with real estate.  

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This change was the result of a landmark court case known as Starker v. United States.  In this case, the court of law ruled that a 1031 exchange could be done within a reasonable time frame instead of simultaneously.  This made the 1031 exchange vastly more easy to pull off and therefore, considerably more popular amongst investors.  This case also helped set forth both the 45-day and 180-day restrictions that we have become so accustomed to today.  In addition to cementing the timelines during which a 1031 exchange should take place, this case also resulted in the prohibition of using a like-kind exchange for partnership interests.

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Throughout the years, there have been very few changes to the 1031 exchange, but that doesn’t mean that people aren’t trying to change the 1031 exchange.  Unfortunately, every few years, the 1031 exchange comes under fire by politicians or activist groups, which leads investors to think that the “loophole” created by section 1031 will be closed.  

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However, it’s important to remember that the 1031 exchange has proven to be a net benefit to the economy.  Studies have suggested that the simple existence of the 1031 exchange is estimated to add roughly $97 billion to US GDP (as of 2021).  Additionally, 1031 exchanges help promote liquidity in the real estate market and are estimated to provide 976,000 jobs (as of 2021).

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How Does a 1031 Exchange Work?

If doing a 1031 exchange sounds like a rather complicated transaction, that’s because they are relatively complex transactions.  However, the benefits of doing a 1031 exchange far outweigh the drawbacks of complexity and cost.  After all, if you own a property that has risen in value considerably since you bought it, not having to pay taxes on those gains can save you hundreds of thousands and, in some cases, millions of dollars.  In order to illustrate just how helpful 1031 exchanges can be, we’ve outlined a realistic example of a forward 1031 exchange below.  

1031 Exchange Example

Let’s say that there is an investor who purchased an apartment building 10 years ago for $500,000.  The property that they purchased had a building on it that was worth $400,000, and the land itself was worth $100,000.  Throughout the years this investor owned the apartment building, they depreciated the building by roughly $145,000.  This would leave the investor with an adjusted cost basis of $355,000.

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Now, let’s assume that this investor wanted to sell his property without doing a 1031 exchange in year 10 for $1,000,000 and that they did not carry forward any losses.  Assuming a 35% effective tax rate (this includes depreciation recapture, federal and state long-term capital gains tax, and net investment income tax), if this investor did not do a 1031 exchange, they would have to pay taxes on their gains of $645,000.  This would mean that the investor would owe the IRS & their state government a total of $225,750.  

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If this investor were to do a 1031 exchange instead of a traditional sale, then they would not have to worry about paying any of those pesky taxes, allowing them to keep control over nearly a quarter million dollars worth of wealth!

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Although this sounds great, there are probably people who are still skeptical of the idea of a 1031 exchange.  Some people argue that it’s better to just go through with a traditional sale, pay your tax bill, and invest the remaining money into something like the S&P 500.  While this certainly is a great idea for investors who simply want out of real estate, it’s actually not the greatest idea when you take a look at the numbers.  Below, we’ll take a deep dive into the numbers:

1031 Exchange vs. Investing in the Stock Market

Let’s assume that the same investor above put down 20% ($100,000) on their apartment building and, over the course of 10 years, paid off roughly 25% of their mortgage ($100,000), meaning at the time of sale, they owe $300,000 to the bank. This would mean that they would retain $700,000 if they were to sell the property using a 1031 exchange or $474,250 if they were to sell using a traditional exchange.  

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If the investor were to do a 1031 exchange, they could then use their $700,000 in sale proceeds to put a 20% down payment on a $3,500,000 apartment complex.  If we assume that the property appreciates at a rate of roughly 2% per year over the course of 10 years, the property will appreciate by roughly $750,000, bringing the total wealth accumulated by the investor to $1,450,000.

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However, if the investor were to make a traditional sale in lieu of a 1031 exchange and invest the post-tax proceeds into the S&P 500, after 10 years, they would have accumulated roughly $1,023,000 in wealth.  This assumes an average annual rate of return of 8% in the stock market.  

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When you combine the 1031 exchange with leverage, two incredibly powerful and unique benefits of investing in real estate, you can generate considerably more wealth over time than if you were to invest your traditional sale proceeds in the stock market.  Although the absolute difference between the two numbers outlined above might seem nominal over 10 years, you can create over 40% more wealth for yourself over time by doing a 1031 exchange!

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If you’re curious to see what a 1031 exchange can do for you and your investments, be sure to use our 1031 exchange deferred gains calculator and our 1031 exchange analysis tools!

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How to do a 1031 Exchange

Now that you understand the benefits of the 1031 exchange and how it is a game changer when it comes to building wealth, you might want to know how to do a 1031 exchange.  

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Unfortunately, a 1031 exchange is a bit more complicated than a traditional sale, so let’s dive into exactly what needs to be done to ensure your like-kind exchange goes off without a hitch.  

What Qualifies for a 1031 Exchange?

One of the most important things to learn about 1031 exchanges is what property types qualify.  While historically all personal property was eligible, now 1031 exchanges are exclusive to “real property”.  The term “real property” is actually quite broad and covers most real estate. It can refer to anything from a one-acre parcel on top of a mountain to the largest skyscraper in the world and everything in between.  

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In order for a property to qualify for a 1031 exchange, it must be considered a “like-kind” exchange of a property that’s held for investment or business purposes.  Fortunately for you, this does not mean that you have to buy a bigger office building when you’re selling your existing office building.  

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Instead, “like-kind” refers to the nature, character, and class of property. In practice, almost all real estate is like-kind to other real estate. This means you can sell your office building, and use it to buy a hotel, or you can sell your shopping center to purchase an apartment building.  You could also sell a warehouse and replace it with vacant land.  

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Unfortunately, though, many people have the false assumption that a 1031 exchange can be done on any property.  Below are some of the most commonly asked questions about specific, niche types of property.

Can a 1031 Exchange Be Done on a Primary Residence?

Although primary residences are pieces of real estate, they do not qualify for a 1031 exchange, simply because they are not pieces of real estate that serve a business or investment purpose.  Some people may see their house as an investment, but the IRS does not, so primary residences do not qualify for 1031 exchanges.  

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Fortunately though, there is a section of the tax code, Section 121, that allows you to exclude a portion of your capital gains when selling a primary residence.  So long as you meet some specific requirements, you can exclude up to $250,000 in capital gains if you’re a single filer, or $500,000 if you’re married filing jointly.  This could save you a considerable amount of money on your tax bill, and potentially completely exempt you from paying taxes on the capital gains you receive from your home.

Can a 1031 Exchange Be Done on Fix and Flip or new develpment?

Property developers are some of the most active buyers in the real estate market, buying and selling swathes of land and homes, all over the country.  Unfortunately for them though, real estate that is used in a “Fix and Flip” and rapidly sold, or property that is held for development purposes, is considered to be inventory by the IRS. Because it’s held as inventory, and not for “investment” purposes, the IRS will not allow 1031 exchanges to be done on these types of properties.  

Can a 1031 Exchange Be Done on a Vacation Home?

Although you can’t do a 1031 exchange on personal property or a primary residence, it is possible to do one on a vacation home, provided you follow a few rules.  The first of which is that the property needs to be rented out at fair market value for at least 14 days per year for the first two years.  

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Additionally, your personal use of the property must be limited to the greater of 14 days per year, or 10% of the time the property is rented out each year.  This means if you rent your property out for 250 days in a year, you can stay at that property for 25 days, and still be able to sell it using a 1031 exchange!  

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This makes the vacation home 1031 exchange a powerful way to invest your money in desirable areas, earn rental income from a property, and reap the tax benefits of a 1031 exchange all at once!

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Can a 1031 Exchange Be Done on Personal Property?

Up until very recently, you could do a 1031 exchange and defer capital gains taxes on personal property, such as artwork, cars and other vehicles, collectibles, and even alternative assets.  However, the Tax Cuts and Jobs Act of 2017 closed this commonly used loophole, so you can no longer do a 1031 exchange on personal property. [only real estate qualifies]

The Qualified Intermediary Requirement

Once you have a property that you’ve identified as being eligible for a 1031 exchange, your next step is to find a qualified intermediary for the transaction.  A qualified intermediary (QI) is going to be a new addition to your real estate transaction team that deals with all aspects of your 1031 exchange.  

What is a Qualified Intermediary?

A qualified intermediary is an independent, impartial third party that will manage the exchange process.  They are responsible for facilitating the entire exchange by ensuring that it abides by the strict guidelines set forth by the IRS.  

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Your QI will assure that the transaction is property structured with the right documents, moves ahead according to schedule, and that you don’t have “constructive receipt” of the sale proceeds at any point during the transaction.  If they fail to do any of these things, your 1031 exchange will be null and void.

What is Constructive Receipt?

Constructive receipt is a term used by the IRS to describe when a taxpayer receives or gains control of the sale proceeds during the exchange process.  Constructive receipt could be something as simple as you, a family member, or friend taking possession of a check payment made when you close on the property you’re selling.  

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This means it’s incredibly important to have a qualified intermediary that is reputable and trustworthy, as they’re going to be responsible for holding onto hundreds of thousands, or potentially even millions of dollars for you while the exchange takes place!

Who Can be my Qualified Intermediary?

One of the main requirements of a qualified intermediary is that they are independent and impartial to the transaction.  Generally speaking, anyone who has acted as a taxpayer’s agent within the two years preceding the 1031 exchange cannot be a qualified intermediary.  This means that friends, relatives, attorneys, real estate agents, and accountants cannot be your QI.  

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Instead, people typically hire an outside firm that specializes in 1031 exchanges, like Deferred.com, to work as their QI.  Oftentimes, these firms' sole business model is to work as QI’s, which means they’re well versed in 1031 exchanges, and the unique laws surrounding them.  

How Does This Work in Practice?

Now that you know what a QI is and what they do, let’s jump back to our example to illustrate what you can expect your QI to do in practice.  When you’re selling your property for $1,000,000, the net proceeds from the sale are wired into a segregated bank account that will hold your funds until you are ready to purchase replacement property . 

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Once it comes time to close on your replacement property, they will wire the funds required to complete the purchase to the closing agent.  At this point, the 1031 exchange is complete.  Additionally, they will ensure that all of the timelines and rules laid out in the next few sections are abided by throughout the entire transaction.  

1031 Exchange Timeline Requirements

Now that you have the property that you want to sell, and your qualified intermediary that will handle the 1031 exchange, the next steps are identifying your replacement property, and completing the exchange.  Unfortunately, these things need to be completed within a very strict time period.  Below, we’ve laid out the most common timeline related rules of 1031 exchanges, the 45-day rule and the 180-day rule, as well as a couple other less known rules:

The Start of The Exchange

Most people don’t realize this, but when you’re doing a forward exchange, the clock starts ticking the day you sell your property.  While many assume that this is technically “day zero”, it’s actually day one.  You’d be surprised how many people miss the deadline on their 1031 exchanges by just a day because of this common misconception!

The 45-Day Identification Period

Now that your property is sold, you have until midnight of the 45th day to identify the property that you are exchanging into when doing a forward exchange.  It’s important that this is done as soon as possible, as doing so will afford you more time to complete the transaction and save you the headache of arguing with the IRS.  

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When identifying a property, it’s important to note that proper identification entails a lot more than picking a listing on LoopNet.  You need to inform your QI of the property that you will exchange into, and they will help you properly document the identified property.  

The 180-Day Purchase Period

The next timeline that you need to worry about is the 180 day purchase period.  This is the last deadline for completion of the exchange itself, and it takes place on day 180, not 180 days after you’ve identified a property.  This means that you need to sell your existing property, identify potential properties to purchase, and close on your new property all within 180 days. 

Holding Periods

Although most people focus on the 45-day and 180-day rules for 1031 exchanges, people often overlook the rules regarding holding periods.  The IRS designed the 1031 exchange to be an incentive for real estate investors, not real estate flippers.  This means there are requirements for how long you must hold both the property that you’re selling and the property that you’re buying in a 1031 exchange.  

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Although there aren’t any explicit rules or laws that state how long you must hold these properties, there was a private letter ruling where the IRS said that a two year holding period is sufficient to demonstrate investment intent.  While this isn’t a hard and fast rule, and private letter rulings aren’t technically precedent, many QIs recommend two years of hold time as a best practice. This means you may need to hold the relinquished property for two years prior to selling, and the purchase property for two years after buying in order for your transaction to qualify for tax deferment under a 1031 exchange.

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If you are selling a property before you meet the two year holding period for an exchange, and you happen to be audited, the IRS auditor will consider a number of factors - like your intended holding time - to determine if your exchange qualifies.   

What Does This Look Like in Practice?

Now that we know the important 1031 exchange timelines, let’s jump back into the example that we outlined above to see what this looks like in practice:

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Since you’ve held your $1,000,000 property for 10 years, it qualifies for a 1031 exchange.  You list your property for sale, and you close on the sale on March 1st.  Your QI takes the proceeds from the closing, and then deposits them into an escrow account.  You would then have until midnight on April 14th to identify potential replacement properties, which includes a $3,500,000 property that you intend to purchase.

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At this point, you would have until August 27th to close on the property that you identified.  Once closing is scheduled, the QI will review the closing documents and wire the required amount of funds from your exchange account to the closing officer, and the property will be yours.  

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1031 Exchange Rules

Now that we know exactly how a typical forward 1031 exchange would work, there are a few niche rules that you should be aware of.  By no means is this a comprehensive list of rules surrounding 1031 exchange, but instead, these are some of the most important ones.  If you want to dive deep into the various rules surrounding 1031 exchanges, be sure to check out this article on 1031 exchange rules, and take a look at our 1031 exchange checklist.

The “Same Taxpayer” Rule

When doing a 1031 exchange, it’s incredibly important to ensure that the entity that owns the relinquished property is the same entity that is purchasing the replacement property.  This ensures the “continuity of investment” that the IRS is looking for.  If there are two different entities selling the relinquished property and buying the replacement property, then the 1031 exchange will be disqualified.

The “Like-Kind Property” Rule

The “Like-Kind Property” rule states that both the relinquished property and the replacement property need to have matching territory and matching purpose in order to qualify for a 1031 exchange.  Matching territory means that both the relinquished and replacement properties need to be in the same territory, so a domestic US property can only be exchanged for other domestic US properties.  Whereas foreign properties can only be exchanged for other foreign properties.  

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Matching purpose simply means both your relinquished property and replacement property must be used for business or investment purposes. You cannot, unfortunately, exchange a property that is for personal use. 

The “Related Parties” Rules

The related parties rule was devised to ensure that the 1031 exchange is a legitimate transaction, and not a tax-avoidance scheme.  This rule essentially states that the purchased properties must be at “arms-length”, and the parties involved must not be related.  This means that your 1031 exchange will be disqualified if you are purchasing property from a relative, an entity where more than 50% of the entity is held by a relative, or for trusts or estates, any executors, trustees, or beneficiaries of the trust/estate.  

The “Identification” Rules

When it comes to identifying your replacement property, there are a few rules that you need to follow.  As we mentioned before, you can’t simply make a mental note that you’ve identified a particular property on LoopNet.  

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Instead, a letter signed by the exchanger(s) must be written that outlines all of a property’s specific details, identifies it as a potential replacement property, and delivered to someone involved in the exchange that isn’t the taxpayer or a disqualified person (this is typically the qualified intermediary) before the end of the 45 day identification deadline.  If you are to change your mind before the end of the 45 day identification period, you can use the same process to revoke and replace the initial letter.  

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Additionally, when identifying a replacement property/properties there are three additional rules to consider regarding the quantity and value of the properties that are being acquired:

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• Three Property Rule:  When doing a 1031 exchange, you can identify up to three properties as potential replacements without regard to their fair market value.  You can then purchase one, two, or all of these properties as a replacement property/properties.
• 200-Percent Rule:  If you want to identify more than three properties, and their fair market value does not exceed 200% of the fair market value of the relinquished property, you can purchase any combination of these properties as replacements.
• 95-Percent Rule:  If you do not meet the conditions laid out by the other two rules, and you have identified more than three properties, under the 95-percent rule, you must acquire 95% of the identified replacement properties before the end of the exchange period.

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That last rule is very uncommon to use, as the requirements are very stringent, and if you don’t comply with the rule, then the exchange is disqualified.  

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The “Equal or Up” Rule

This rule is quite possibly one of the simplest rules that you have to abide by in a 1031 exchange.  The “Equal or Up” rule states that the replacement property should be worth more than the relinquished property that is sold.  

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You’ll also need to go “Equal or Up” on the amount of debt  taken out on a property as wellThe replacement property should have either the same amount of debt taken out against it, or more.

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If you do not exchange “Equal or Up”, you will not fully defer your capital gains. However, your exchange may still partially defer some of your taxes depending on the scenario. We’ll cover this more in the next section on calculating your taxable gain below. But to understand how this impacts your potential exchange, you can check out our exchange calculator to run some scenarios. 

State Specific Rules

Unfortunately, in addition to the rules set forth by the IRS, some states have their own rules regarding 1031 exchanges.  Each state treats 1031 exchanges differently, so going through the specific rules for each state is outside the scope of this article.  However, we have state specific resources that can tell you the unique rules your state has regarding 1031 exchanges.  

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How to Calculate Taxable Gain in a 1031 Exchange

In a 1031 exchange, the goal is to defer capital gains taxes entirely, but certain situations can trigger a taxable event. These taxable portions are referred to as “boot.” Understanding the concept of boot and how taxable gain is calculated is crucial to optimizing the tax benefits of an exchange.

Determining Taxable Gain

Taxable gain in an exchange happens when the value of the replacement property is less than the value of the relinquished property or when not all of the proceeds from the sale are reinvested. The “equal or up” rule is a guiding principle:

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To fully defer taxes, you must reinvest all the sale proceeds from the relinquished property and acquire a replacement property that is equal to or greater in value.  Additionally, any existing debt on the relinquished property must be replaced with at least an equal amount of debt on the replacement property or newly invested cash equity.  When these requirements aren’t fully met, the difference becomes boot, which is taxable.

Types of Boot

Cash Boot:  Cash boot occurs when the investor doesn’t reinvest all the proceeds from the relinquished property into the replacement property. For example, if a property is sold for $1,000,000 and only $900,000 is reinvested, the remaining $100,000 is cash boot and subject to taxes. This often happens when an investor receives leftover cash after the exchange or when an investor decides to take some cash out at closing from the sale of their relinquished property.

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Mortgage Boot:  Mortgage boot arises when the debt on the relinquished property is not fully replaced with debt (or with newly invested cash) when the replacement property is purchased. For instance, if the relinquished property had a $500,000 mortgage but the replacement property has only a $400,000 mortgage, the $100,000 shortfall is considered mortgage boot. To avoid this, investors typically replace or exceed the original debt amount.

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Non-Cash Boot:  Non-cash boot refers to any non-cash benefit received during the exchange, such as personal property, services, or other compensation. These items are not considered “like-kind” and are therefore taxable.

Fully Deferred vs. Partial Exchanges

In a fully deferred exchange, all proceeds and debt are reinvested into a like-kind property that meets or exceeds the value of the relinquished property. In this scenario, no taxable gain is triggered, and the investor benefits from complete tax deferral.

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In a partial exchange, some of the proceeds or debt are not reinvested, resulting in a partially taxable gain. For example:

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If a relinquished property sells for $1,000,000 and the replacement property is purchased for $950,000, the $50,000 difference would be taxable as boot.  Similarly, if any cash is retained or debt replaced falls short, the resulting shortfall triggers a taxable event.

The Different Types of 1031 Exchanges

Now that you’ve gotten to this point in the article, you might be of the belief that there is only one type of exchange, the forward exchange.  Although this is by far the most commonly used type of 1031 exchange, there are a couple of other types of exchanges that are available for use.  Most people can satisfy their 1031 exchange needs through a forward exchange.  However, there are some niche cases where a reverse 1031 exchange or an improvement 1031 exchange can be used.  Below, we delve into the differences between these three types of exchanges.  

The Forward 1031 Exchange

As we mentioned, the forward exchange is the most commonly used type of exchange.  This is why in the example that we have referred to throughout this article is based on a forward exchange.  In a forward exchange, the relinquished property is sold prior to the purchase of the replacement property.  

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This makes the forward exchange rather simple to pull off, which is why it’s often the cheapest type of exchange to do in terms of fees. At Deferred.com,we offer  “No Fee” forward exchanges to make saving on taxes accessible for every investor.  The forward exchange is great for anyone who is looking to “trade up”, but is still in the process of looking for their next investment property.  

The Reverse 1031 Exchange

As the name would suggest, the reverse exchange is done in the opposite order of the forward exchange.  With a reverse 1031 exchange, the replacement property is bought prior to the sale of the relinquished property.  

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When doing a reverse exchange, your qualified intermediary will take on the additional responsibility of the Exchange Accommodation Titleholder, also known as the EAT.  The EAT is responsible for receiving funds from the investor, purchasing the replacement property, and then “parking” it by retaining ownership of the property until the exchange is completed (when the relinquished property is sold).  Once the exchange is completed, the EAT then transfers ownership of the replacement property to the investor.  

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It’s important to note that when doing a reverse exchange, you’re still required to adhere to the 180 day rule, meaning the sale of relinquished property needs to be complete within 180 days.  Day One begins when the replacement property is purchased, and you have until day 180 to sell your relinquished property.

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Although you technically are not the owner of the property while the EAT holds the title of the property, you will take over operations of the property and you are still financially responsible for the property.  This means that you are required to maintain the property, pay property taxes, and make repairs.  Fortunately though, this also means that you have the option to make improvements (called a “Reverse Improvement Exchange”) to the property while waiting to close on the relinquished property!

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Reverse exchanges are particularly helpful if you find a deal that you want to purchase, but you’re not ready to sell your existing property yet.  Doing a reverse exchange allows you to be patient selling your relinquished property  to ensure that you get top dollar without having to pass up a great deal!

The Improvement 1031 Exchange

The improvement exchange is another great way to take advantage of section 1031 of the tax code.  As you might guess from the name, the improvement exchange allows you to use tax-deferred dollars to make improvements to the replacement property.  These improvements can be something as simple as renovations to an existing building, or it can be something as complex as an addition to a building, or even a brand new structure!

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Since you can do both forward and reverse improvement exchanges, you still need to abide by the respective timelines that these exchanges adhere to.  This means that even improvement exchanges need to be completed within 180 days.  However, where improvement exchanges differ is that in addition to identifying a property, you need to identify (and complete) the improvements that will be done to the property within the 180 day window.  

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When you identify the improvements that you are making to a property in an improvement exchange, you must include a description of the improvements to be made. Throughout the process, you’ll also want to keep extensive documentation, including, but not limited to, quotes, plans, and timelines for work.  This will all be documented and presented to the IRS, should they come looking for supporting documentation.  

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During the improvement process, the title of your replacement property, as well as any proceeds from the sale of your relinquished property will be held by your qualified intermediary to ensure compliance with IRS regulations. When it comes time to pay for the improvements to the property, the QI can use the exchange funds to pay contractors and avoid any issues with constructive receipt. 

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Improvement 1031 exchanges are great for those looking to purchase a property that might need work, or raw land that can be developed into new construction, and allow an investor to buy with a “value-add” strategy.  They allow the investor or business to tap into the capital generated by their relinquished property, and add considerable value to the replacement property before they take ownership of the property.  

Which Type of 1031 Exchange is Right For You?

The perfect type of 1031 exchange is going to be heavily dependent on the situation that you’re in.  For most people, the forward 1031 exchange is easy to understand, cost-effective (or free with Deferred.com!), and relatively straightforward. .  

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However, if you need to make improvements to your replacement property the improvement exchange might be a better option.   Or if a great deal comes across your desk before you’re ready to sell your relinquished property, then the reverse exchange is probably the best bet for you.  

How Much Does a 1031 Exchange Cost?

The 1031 exchange has traditionally been a very expensive transaction, with some firms charging investors thousands of dollars and keeping all of the interest they accrue on the money that they hold for you.  However, Deferred has set out to break the mold of the traditional exchange.  We’re one of the only companies out there that offers a no-fee forward 1031 exchange.  

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Additionally, for exchanges of $500,000 or more, we actually pay you a portion of the interest that we receive when holding your money!  This means you can do a 1031 exchange and walk away with more money than you started with. 

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If you’re not doing a traditional forward exchange, we can help you out with specialized exchanges too.  Both our reverse exchanges and improvement exchanges start at just $5,999.

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To learn more about how much interest you can earn by doing a forward exchange with us, or to request a quote for a reverse or improvement exchange, check out our pricing page.

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The Pros and Cons of a 1031 Exchange

Although 1031 exchanges sound great, there are both benefits and drawbacks to completing one.  In order to better help you understand the benefits and drawbacks of 1031 exchanges, we’ve assembled a list of pros and cons below:

Pros

• Deferral of Capital Gains Taxes: The primary benefit of a 1031 exchange is the ability to defer taxes on the sale of an investment property. This allows investors to reinvest the full proceeds into a new property, maximizing their purchasing power and growth potential.
• Increased Cash Flow and Wealth Accumulation: By deferring taxes, investors can acquire larger or higher-yielding properties, leading to increased rental income and property appreciation over time.
• Portfolio Diversification: A 1031 exchange enables investors to diversify their portfolio by exchanging one property for another type. For example, an investor might trade a single-family rental property for a multifamily property or commercial real estate.
• Consolidation or Expansion Opportunities: Investors can use 1031 exchanges to consolidate smaller properties into one larger asset or divide a large property into multiple smaller assets to suit their investment strategy.
• Legacy Building: When investors hold exchanged properties until their death, their heirs receive a step-up in basis, effectively eliminating the deferred capital gains tax liability.

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Cons

• Strict Timeline Requirements: Investors must adhere to rigid deadlines: a 45-day identification period and a 180-day closing period. Missing these deadlines results in the loss of tax deferral benefits.
• Complex Rules and Eligibility Criteria: Properties must be “like-kind” and held for investment or business purposes. Personal-use properties, such as primary residences, don’t qualify. Navigating these rules can be challenging without expert guidance.
• Limited Flexibility: The “equal or up” rule requires investors to reinvest all proceeds and match or exceed the value and debt level of the relinquished property. This can limit flexibility if the investor wants to downsize or free up cash.
• Taxable Boot: If the replacement property’s value is less than the relinquished property or if not all proceeds are reinvested, the difference (known as “boot”) becomes taxable, reducing the tax benefits.
• Transaction Costs: While a 1031 exchange defers taxes, it doesn’t eliminate closing costs, intermediary fees, or legal expenses. These costs can add up, especially for complex exchanges.
• Market Risks and Property Management Challenges: Reinvesting in real estate means remaining exposed to market risks and property management responsibilities, which may not align with an investor's goals for diversification or reduced workload.

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Partner With Deferred For Your Next 1031 Exchange

A 1031 exchange is a relatively complex process, and requires quite a bit of oversight from both the investor and the qualified intermediary.  That’s why choosing the right qualified intermediary is key to achieving a successful transaction.  

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The Deferred team brings over 40 years of collective 1031 exchange experience to the table in addition to the latest and greatest technology.  If you want to learn more about our no-fee forward exchanges, or our low-fee reverse and improvement exchanges, feel free to call 866-442-1031 to speak with one of our trusted team members, or schedule a meeting online today.

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If you want to learn more about 1031 exchanges, we have a wide variety of articles covering virtually every 1031 exchange question you can think of.  Should there be a question that we haven’t answered, we have a 1031 exchange chatbot called ARTE that has been trained on thousands of 1031 exchange related articles, amendments, and publications from the IRS.  ARTE can provide you with answers to your questions instantly, and completely for free!  

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