What Is a 1031 Exchange?
Under Section 1031 of the Internal Revenue Code of 1986, as amended, a taxpayer may exchange property held for investment or productive use in a trade or business for like-kind replacement property intended for the same purpose.
Real estate may be exchanged for like-kind real estate, and personal property may be exchanged for like-kind personal property. Personal property cannot be exchanged for real estate.
Key 1031 Exchange Terms
- Relinquished Property: The property you intend to sell or exchange.
- Replacement Property: The property you intend to purchase or receive in the exchange.
- Closing Agent: The person or organization handling the closing, such as an attorney, escrow company, or title company.
- Exchangor or Taxpayer: The person or organization completing the exchange—you.
- Qualified Intermediary (QI): The company that manages the 1031 exchange transaction, such as Exchange Solutions Group, LLC.
What Property Can Qualify?
Like-kind real estate can include many different types of property, provided it is held for investment or productive use in a trade or business. Examples may include residential rental properties, office buildings, shopping centers, net lease properties, oil and gas leases, leases with at least 30 years remaining, and vacant land.
Property generally cannot be exchanged if it is a taxpayer’s primary residence, a second or vacation home (except in limited circumstances), or property held primarily for sale, such as inventory or property held for flipping.
Many taxpayers exchange one rental property for another, though other qualifying real estate options may be available.
Important 1031 Exchange Deadlines
The exchange timeline begins on the day you close on your Relinquished Property. After closing, you generally have 45 days to identify potential Replacement Property or Properties. You generally have 180 days from the closing date—or until your tax return is due, if earlier—to complete the exchange.
These deadlines generally cannot be extended, except in certain federally declared disaster situations. If your exchange begins in October or later in the year, you may be able to extend your tax return filing deadline to preserve the full exchange period. See “6 Rules for Structuring 1031 Exchanges” below.
Your QI will provide your important 45-day and 180-day dates in writing and can answer questions about the exchange process.
For additional information, contact Coakley Realty by phone or online.
How to Start a 1031 Exchange
Your Qualified Intermediary will need the following items to begin setting up the exchange:
- A purchase and sale agreement. Send a copy to the QI by fax or email. The agreement or an addendum prepared by your broker or agent should include language similar to the following: Despite anything in this agreement to the contrary, the seller may assign the seller’s rights under this agreement to Exchange Solutions Group, LLC (“ES Group”) as the seller’s qualified intermediary. ES Group will then be allowed to sell the property as part of a like-kind exchange in accordance with Section 1031 of the Internal Revenue Code. In order to complete the sale of the property as part of an I.R.C. §1031 exchange, Purchaser/Buyer shall reasonably cooperate with Seller and/or any permitted assignee; however, Purchaser/Buyer shall not incur any additional costs or liabilities associated with such an exchange, nor shall closing be delayed due to such exchange.
- A completed Exchange Information Form. The form includes the Exchangor’s name, tax identification number, sale price, closing date, exchange proceeds, and the closing attorney or title company’s contact information.
Have questions? Coakley Realty can assist. Call or contact us online.
What to Expect During the Exchange
1. Contact the QI Before Closing
The QI must be involved before the sale of your Relinquished Property closes. After receiving your purchase and sale agreement, application, and title information, the QI will prepare the exchange documents required for the transaction.
Exchange documents often include:
- Exchange Agreement: An agreement between you and your QI that outlines the exchange terms and deadlines.
- Assignment: Gives the QI authority to handle the property transaction on your behalf.
- Notice of Assignment: Notifies the buyer of your Relinquished Property that you are completing a 1031 exchange. The buyer must receive this notice before or at closing. The buyer typically signs it to acknowledge the exchange.
- Closing Agent Instructions: Instructions from the QI explaining how the closing agent should handle the exchange documents and prepare the closing paperwork. These instructions also include wiring details for transferring the sale proceeds to your exchange account.
- Identification Form: A form used to identify your Replacement Property or Properties within 45 days of closing on the Relinquished Property.
The QI will help you with the identification process. Before closing, the exchange paperwork will be provided to you, your attorney, and/or the closing agent.
2. Close on the Relinquished Property
The sale settlement statement, often a HUD-1 form, will identify your Qualified Intermediary in the transaction. You will sign the statement to approve the sale.
The closing agent will send the net sale proceeds to the QI. These funds will appear on the settlement statement as exchange proceeds. You generally will not receive the proceeds directly unless you are receiving funds from the closing, which may be taxable.
The settlement statement will also show the QI’s exchange fee, which may be deducted from the sale proceeds.
3. Keep Exchange Funds Secure
Your exchange proceeds are transferred to a separate account in your name that tracks your tax identification number, earns interest, and is not combined with other assets.
Each distribution from the exchange account requires two signatures: one from you or your designated representative and one from the QI. The QI will request the wire transfer or, in rare cases, a check.
4. Identify and Purchase Replacement Property
After you sign an agreement to purchase an identified Replacement Property, notify your QI and send them the purchase contract by fax or email. The contract or an addendum prepared by your broker or agent should include language similar to the following:
Purchasers/Buyers may assign their rights under this Agreement to Exchange Solutions Group, LLC (“ES Group”) as a qualified intermediary for the Purchasers, notwithstanding anything in this document to the contrary. ES Group will then be allowed to buy the Property as part of a like-kind exchange under Section 1031 of the Internal Revenue Code. In order to complete the purchase of the property as part of a 1031 exchange, Seller shall reasonably cooperate with Purchasers/Buyers and/or any permitted assignee; however, Seller shall not incur any additional costs or liabilities associated with such an exchange, nor shall closing be delayed due to such exchange.
5. Arrange the Earnest Money Deposit
You may provide the earnest money deposit for your Replacement Property directly. This is common and is often the simplest approach.
If you need to use exchange funds for the deposit, notify your QI. The QI will need a signed copy of the purchase contract and the deposit wiring instructions. After receiving these items, the QI will email you a 1031 Assignment and Earnest Money Request Form.
Once the QI receives the signed request form, the requested funds can be sent to the deposit holder. Exchange funds cannot be paid directly to you.
6. Close on the Replacement Property
Provide your QI with the closing agent’s name and contact information as soon as possible. The QI will coordinate the remaining steps. The closing procedures used for the Relinquished Property—such as the Assignment, Notice, and Closing Agent Instructions—will also apply to the Replacement Property.
On the closing date, the QI will send your exchange proceeds to the closing agent.
7. Review the Purchase Settlement Statement
The purchase settlement statement, often a HUD-1 form, will identify your Qualified Intermediary as the buyer. You will sign the statement to approve the transaction.
The QI will send the exchange funds to the closing agent, typically by wire transfer. The funds will appear on the settlement statement as exchange proceeds. Any remaining amount needed to complete the purchase will appear as the balance due from the buyer, also called the borrower.
Arrange with the settlement agent to provide any remaining balance by cashier’s check or wire transfer before closing.
Final Step: Complete Your Tax Filing
Your exchange is complete once you have closed on your Replacement Property or Properties. Keep copies of your settlement statements, deeds for each transaction, and all exchange documents.
You must include IRS Form 8824 with your tax return.
