1031 Exchange Timelines

You may have heard that a 1031 exchange can help you sell a property and push off your capital gains taxes. It’s one of the most powerful tools real estate investors use to compound their investment over long periods of time. But talk to any investor who has done an exchange and you’ll immediately hear about “the timeline” - there were a bunch of rules they needed to follow and, unless they did a lot of upfront planning, they probably felt stretched to close the deal in the required time frame.

So what is the timeline for a 1031 exchange? There are time limits related to the exchange process itself, and there are other timeline considerations before and after the exchange. The full timeline looks like this.

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Below we'll cover why these timelines matter, the penalties for missing the milestones in an exchange, review each key date within a like-kind exchange, and go in-depth on some lesser known time limits that are important to consider before and after your 1031 exchange.

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Why does timing matter?

From the perspective of the IRS, you can defer taxes on a like-kind property exchange because there is a “continuity of investment”. You are trading one property for another and have not “recognized” your profits yet. There are many rules that determine whether or not an exchange of property qualifies for this type of treatment, but the time it takes to complete a transaction is maybe the most important.

We’ll go into the history of this later, but through the mid-1970s exchanges had to be “simultaneous” and were really clunky. To make sure gains weren’t recognized, investors would literally swap title to properties in one transaction and without exchanging cash. You could imagine finding someone to swap with would be difficult, and they might not have the exact type of investment you want, so it was common to have simultaneous exchanges with many investors (3? 5? 10?) swapping properties in a chain reaction just to avoid paying their capital gains. This was obviously very clunky.

A modern 1031 exchange, also called a “delayed exchange”, “forward exchange”, or “starker exchange” does not require investors to swap properties in a single transaction. To make sure that investors do not abuse this more relaxed treatment, they set very firm boundaries on the amount of time you have to complete a property exchange.

If you miss the time limits the IRS has set in place the penalties are stiff - your entire transaction is taxable and you will have to pay capital gains taxes on your property sales.

The timeline is incredibly strict because it’s clearly written into law as part of the Code of Federal Regulations for Section 1031. There have been many cases where the courts have reinforced the letter of the law when it comes to these types of time frames. It can actually go beyond just missing your exchange timeline, as in the case of Christensen vs. Commission, Int. Rev. There are cases where a Qualified Intermediary had their assets frozen, investors missed their deadline and had to pay taxes. Or a Qualified Intermediary goes bankrupt and investors can’t get their funds in time.

There is one case where the timeline for an exchange can be extended and that is if there is a natural disaster.

The time frame for an exchange is unforgiving and the penalties are high! So let’s dig into the specifics.

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What is the time frame for a 1031 exchange?

The simple answer is you have 180 days to complete a 1031 exchange. You must identify any replacement property within 45 days for the exchange to qualify. These are the two most important dates to track throughout your exchange process.

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The legal definition as part of 26 CFR 1.1031(k)-1(b)(2) is actually fair straightforward:

(2) Identification period and exchange period.

(i) The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.

(ii) The exchange period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) for the taxpayer's return of the tax imposed by chapter 1 of subtitle A of the Code for the taxable year in which the transfer of the relinquished property occurs.

(iii) If, as part of the same deferred exchange, the taxpayer transfers more than one relinquished property and the relinquished properties are transferred on different dates, the identification period and the exchange period are determined by reference to the earliest date on which any of the properties are transferred.

(iv) For purposes of this paragraph (b)(2), property is transferred when the property is disposed of within the meaning of section 1001(a).

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Day 1 - Starting the clock

The clock starts when the first transaction closes. For a forward exchange, this is the date of sale for the relinquished property.

For the purposes of calculating the exchange timeline, the date of sale is Day 1 of the timeline - don’t make the mistake of treating the sale date as “Day Zero” and missing your exchange deadlines by a day!

If there are multiple properties being sold as part of the exchange, then the earliest date of sale will be used to start the clock.

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45 day identification period

The next milestone to track happens on Day 45. If you can complete the entire exchange process by this date, you’re done (and you should congratulate yourself on your flawless planning abilities!)

But for most people, this is the deadline to identify the property you are exchanging into. In a forward exchange, that means the replacement property you intend to buy with your cash proceeds. The deadline is midnight of the 45th day but you should attempt to identify properties sooner. You do not want to find yourself arguing with an IRS auditor over what timezone should be used for “midnight” in your transaction.

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180 day purchase rule

The last milestone is the 180 day time limit for an exchange. Your entire process must be complete, with all closings for relinquished property you sold and replacement property you purchased being complete.

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The lesser known timelines

Most people focus on the 45 day and 180 day timelines for a like-kind exchange because they’re the most stressful. You’ve sold a property, you’re hunting for a replacement, and you (hopefully) have a team of professionals focused on getting your deal through the finish line.

But there are other time limits that you need to consider as part of an exchange. They’re often forgotten about or never discussed, but they’re just as important because missing them leads to the same penalty - paying the full taxable gain on your transaction.

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Tax Filing Timelines

Filing your taxes while processing an open exchange will ruin the exchange process. This is a very easy rule to break, these things are seemingly unrelated and it’s easy for an investor or a CPA to file the tax return without thinking, resulting in a huge capital gains tax that could have been avoided.

The reason the IRS cares about this is because they want taxpayers to report on the sale of any property within that tax year. Properly deferring gains requires filing Form 8824 along with the rest of your tax documents. For example, if I sell a property in December 2023, I would have until May 2024 to complete the exchange. But the IRS wants me to report on my like-kind exchange with my 2023 taxes. If I were to file my 2023 taxes in April 2024 (before the April 15 deadline), I will have reported on my sale and will owe the respective capital gains taxes.

To avoid this problem, you’ll want to file an extension on your taxes if you are in the process of an exchange during a filing deadline. Once your exchange is complete you would file along with your Form 8824 reporting the exchange, successfully deferring any capital gains.

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Holding Periods

We cover this in more depth in our 1031 Exchange Rules article, but a key part of a 1031 exchange states the property must be “held for investment”. The IRS has a very specific perspective on this, and one component is the ownership time period.

The IRS wants to reward long term investors (by deferring capital gains taxes), but they want to make sure they’re appropriately taxing short term investors for things like “fix-and-flips”. So how long do you need to own a property to qualify as a long term investor?

This isn’t strictly defined in the internal revenue code or the regulations, but in Private Letter Ruling 8429039 the IRS said a two year holding period is sufficient to demonstrate investment intent. In some cases, an aggressive interpretation of this ruling says that “two tax periods” would also be sufficient, which could shorten the holding period to as little as 13 months.

It’s important to know that this applies to the property you hold going into an exchange, the relinquished property. But it also applies to the replacement property you acquire. The IRS can review prior tax returns during an audit and, if you do not meet the holding requirement after the exchange for your replacement property, your exchange could be disqualified and you may end up being taxed on the sale after the fact.

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Holding Periods for Related Parties

The rules are particularly stiff if you’re exchanging with a related party. To ensure that an exchange is not otherwise used to dodge taxes, both the investor performing the exchange and the buyer of the relinquished property need to meet the two year ownership periods. For example, say you’re selling your multi-family property to your brother as part of an exchange. If 14 months later your brother decides to sell the property to a third party, your original exchange can be invalidated and you can owe back taxes.

To understand if this rule applies, the transaction must involved a related party is defined by Section 267(b):

• Members of a family, as defined in subsection (c)(4);
• An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
• Two corporations which are members of the same controlled group (as defined in subsection (f));
• A grantor and a fiduciary of any trust;
• A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts;
• A fiduciary of a trust and a beneficiary of such trust;
• A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts;
• A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust;
• A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual;
• A corporation and a partnership if the same persons own--
  • more than 50 percent in value of the outstanding stock of the corporation, and
  • more than 50 percent of the capital interest, or the profits interest, in the partnership;
• An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation;
• An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation; or
• Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate.

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Reverse Exchange Timelines

A reverse exchange is a type of like-kind exchange where you acquire a property first, then work to sell the property you’re exchanging. This type of exchange, also called a “parking arrangement”, happens in the reverse order of a traditional “forward” exchange. Once controversial, the IRS clarified the rules and established a safe harbor for these types of exchanges in Revenue Procedure 2000-37.

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While the buying and selling of properties happens in a different order, the spirit of the timelines for the exchange still apply:

• The replacement property is bought by a Qualified Intermediary (or in this case an “Exchange Accommodation Titleholder”), with the closing date starting Day 1 of the exchange.
• The taxpayer has 45 days to identify the relinquished property they intend to sell to complete the exchange.
• The taxpayer has 180 days to finalize the sale of the relinquished property and complete the exchange.
• The tax filing timeline requirement is the same as a forward exchange.
• The holding period requirements are the same as a forward exchange.

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Construction & Improvement Exchange Timelines

Construction and improvement exchanges are similar to a forward exchange, with the twist that some of the proceeds from the sold property are being used to either build or renovate the newly acquired property. This can be great for investors with some development experience who want to make use of a value-added investment strategy.

When it comes to construction or improvement exchanges, the time limits are the same as a forward exchange, with some additional nuance for funds that are spent on construction or rehab.

• The clock starts with the sale of the first relinquished property
• The taxpayer has 45 days to identify replacement property.
  • In this case, replacement property includes both the property being purchased and use of proceeds for construction or rehab. Individual budget items like roof replacements, systems work like plumbing or electric, material purchases, etc. that will be purchased with exchange funds will need to be identified.
• The taxpayer has 180 days to complete the exchange, which includes purchasing the property and completing any identified construction or remodeling projects.
  • In this case, only the identified projects need to be complete. For example, when purchasing raw land and building a new home as part of an exchange, a developer might struggle to complete construction within 180 days. If they had $20,000 in exchange proceeds left after acquiring the land, and they intended to finish the rest of the project with other funds, they may just identify the major line items to start a project, like grading the lot, pouring a foundation, and hooking up utilities as part of the exchange. As long as those projects are complete within the 180 day timeline, the exchange is valid and they can continue to develop the property beyond the deadline.

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History of 1031 Exchange Timelines

How were these timelines set? And could they potentially change during your exchange? To understand this, it’s helpful to cover a brief portion of our history of 1031 exchanges.

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Horse Trading

Originally, like-kind exchanges were created out of a practical need. Many business owners would barter property, like horses, cattle, or even farms. Lawmakers realized that tracking and taxing these transactions would be fairly difficult, so as part of the Revenue Act of 1921 the like-kind exchange was written into the tax code.

Trading two horses happens “instantly” - you don’t have to deal with financing, a title company, or any of the other complexities of a real estate transaction. Applying this same line of thinking, and based on the language in the tax code at the time, real estate investors had to pull off an “instant”, or “simultaneous” transaction to complete a 1031 exchange and qualify for the tax deferral.

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The Starker Exchange

Obviously this was clunky and hard to accomplish, so exchanges were not as popular. Then one enterprising man, T.J. Starker, and his team of lawyers came up with a create interpretation of the laws - instead of doing a simultaneous swap of properties, the Starkers transferred their timberland to a third party, the third party completed the buy and sale transactions, and then transferred the replacement property back to the Starkers to complete the exchange. This was the first use of a “qualified intermediary” to complete an exchange and it was a revelation.

Of course, the pioneers get the arrows, and the IRS challenged the transactions. Ultimately, the courts ruled in Starker v. United States that Section 1031 did not explicitly require a simultaneous transaction and established that a broader timeline to complete an exchange could qualify.

In response to the ruling in the Starker case, Congress eventually amended Section 1031 to formalize the process for a “Starker” exchange, which is now more commonly known as a delayed or forward exchange. Regulations were added under 26 CFR 1.101(k)-1 that established the modern timelines that are in use today.

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