A 1031 Exchange allows an investor to sell a property, reinvest the proceeds into a like-kind new property, and to defer all capital gain taxes. If you are a new investor we highly recommend you hire a team that consists of a good broker, qualified intermediary, CPA, and attorney. When done correctly the result is either zero or limited tax due at the time of the exchange. There’s no limit on how many times you can do a 1031, you can roll over the gains from one investment to another, to another, and so on. The exact definition is below:
IRC Section 1031 (a)(1) states:
“No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment, if such real property is exchanged solely for real property of like-kind which is to be held either for productive use in a trade or business or for investment.”
The term “like-kind” often throws many people for a loop. Does this mean if I sell an O’Reilly Auto Parts I can only buy another Auto Parts deal? The answer is no. You can exchange almost any type of commercial real estate for another. For example you can exchange an apartment building for raw land, a triple net property, a ranch, a strip mall, etc. You can even exchange one business for another.
The Role of Qualified Intermediaries
A Qualified Intermediary is s a person or company that agrees to facilitate the 1031 exchange by holding the funds involved in the transaction until they can be transferred to the seller of the replacement property. The qualified intermediary has no other relationship with the parties exchanging property.
1031 Timeframe Regulations
The two main days you need to keep track of when doing a 1031 exchange are Day 45 and Day 180.
Once you officially sell your property (The Down-leg) the intermediary will receive the funds. You CAN NOT receive the funds, or it will ruin the exchange! Within 45 days of the sale of your property, you must designate a replacement property in writing to the intermediary. You are allowed to designate three properties as long as you eventually close on one of them. It is very common in the triple net world for a potential buyer to tie up 3 properties knowing they only are going to eventually close one of those. As long as you are transparent with everyone involved in the transaction that is not a frowned upon way of doing business.
We ALWAYS recommend using all three slots, because you never know what can go wrong on a deal. If you absolutely love a property and only designate that as your replacement you are leaving yourself open to a potentially bad situation. While the marketing package may have looked great for the asset, you never know what you are going to find when you get into the due diligence phase. DO NOT make the mistake of only designating one property.
The second timing rule is that you have to close on the new property (Up-Leg) within 180 days of the closing of your property (Down-leg). Note that the two time periods run concurrently. That means you start counting when the sale of your property closes. If you designate replacement property exactly 45 days later, you’ll have just 135 days left to close on the replacement property.