For investment-property owners
The 1031 exchange guide for East Bay investment-property owners
How a 1031 exchange works, in plain language: what qualifies, the 45 and 180 day deadlines, the qualified intermediary, and how we time your sale and your purchase.
What a 1031 exchange is
A note before you start: we are real estate agents, not tax advisers or attorneys. Every exchange should be set up with a qualified intermediary and a tax professional before the sale of your current property closes. If that sale closes without an exchange in place, it is generally too late to start one.
A 1031 exchange takes its name from Section 1031 of the Internal Revenue Code. In plain terms, it lets you sell an investment property and put the proceeds into another investment property while deferring the federal tax you would otherwise owe on the gain. To defer means to put off until later. It does not mean the tax goes away.
The property you sell is called the relinquished property. The one you buy is the replacement property. What follows are the general federal rules. Your tax adviser and your qualified intermediary will confirm how they apply to you. California may have its own requirements too, so ask your tax adviser about those.
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What qualifies, and what does not
The general rule is that both properties must be held for investment or for use in a trade or business. A rental house, a commercial building or land held as an investment can all fit.
- Your primary residence does not qualify. The home you live in falls under separate tax rules. If you are selling your own home to buy another, our trading up guide is the better place to start.
- Property held mainly for sale does not qualify. A house you bought to fix up and resell quickly is generally treated as inventory, not an investment.
- The properties must be like-kind. Like-kind is broader than it sounds. In general, real property in the United States can be exchanged for other real property in the United States, so a rental house could be exchanged for land or a small commercial building.
Whether your specific property qualifies is a question for your tax adviser. Ask it early, before you list.
The two deadlines: 45 days and 180 days
Two clocks start the day the sale of your relinquished property closes. They count calendar days, weekends and holidays included.
- 45 days to identify. Within 45 days of the sale, you must identify your possible replacement properties in writing. To identify means to name the specific properties you might buy, usually by address, in a signed document delivered the way your qualified intermediary instructs.
- 180 days to close. You must close on the replacement property within 180 days of the sale, or by the due date of your tax return for that year including extensions, if that comes first.
The two clocks run at the same time. The 180 days is not 45 days plus 180 more. These deadlines generally do not stretch for a slow market or a failed deal, so start your search well before the sale closes.
The qualified intermediary holds the money
A qualified intermediary, often called a QI or an exchange accommodator, is an independent company that holds your sale proceeds during the exchange and uses them to buy your replacement property. You choose the QI and sign their exchange agreement before your sale closes.
The key rule: you must not take receipt of the money. If the proceeds are paid to you, even briefly, the exchange generally fails. California is an escrow state, which means a neutral escrow company handles each closing. In an exchange, escrow sends your proceeds to the QI when the sale closes, and the QI sends them into escrow when you buy.
Your tax adviser can explain who is allowed to serve as your QI and help you choose one.
Boot: the part that can still be taxed
Boot is the term for anything you receive in an exchange that is not like-kind property. The two common forms are cash and debt reduction.
- Cash. If some of the sale proceeds come back to you instead of going into the replacement property, that amount can be taxable.
- Debt reduction. If the loan on your replacement property is smaller than the loan paid off on the property you sold, the difference can be treated as boot and can be taxable.
As a general rule, investors aim to avoid boot by buying a replacement property of equal or greater value and reinvesting all of the proceeds. Your tax adviser will run the actual numbers for your situation. We will not guess at them.
How we coordinate the sale and the purchase
Our job is the real estate side: selling your current property, finding and evaluating replacement properties, and keeping both transactions on a timeline that respects your deadlines. We work alongside your qualified intermediary and your tax adviser so everyone is working from the same dates.
- Talk to your tax adviser first. Before anything is listed, confirm with your tax adviser that an exchange makes sense for you, and choose a qualified intermediary.
- Price the property you are selling. We prepare a home valuation so you know roughly how much you will be reinvesting.
- Start the replacement search early. We begin touring and running numbers on replacement properties before your sale closes, so your 45 days are spent deciding, not searching. Our investment property guide covers how we evaluate a rental.
- List and sell. We market your property and negotiate the sale. If the property is leased, the tenants' rights under their lease and California law continue, and we plan showings and timing with that in mind.
- Put the exchange in place before closing. Your QI's exchange agreement is signed, and escrow is told the sale is part of an exchange.
- Identify in writing. Within 45 days of the sale, you identify your replacement properties in writing through your QI. We help you narrow the list.
- Close on the replacement. We write and negotiate an offer with contract dates that fit inside your 180 days, and the QI sends the funds to escrow.
Our commission on each transaction is set by a written agreement with you and is negotiable. You can see how we handle each step in our process.
Common ways exchanges fail
- Missing a deadline. Day 45 and day 180 do not move because an inspection ran long or a loan was slow. The contract dates on your replacement purchase have to be set with those deadlines in mind.
- Touching the money. If the sale proceeds are paid to you, the exchange generally fails. Bringing in a QI after the sale has closed is too late.
- Identifying too late, or too narrowly. Starting the search after the sale closes leaves little time to choose well. Naming only one property can leave you with nothing to buy if that deal falls apart. Your QI will explain the rules on how many properties you can identify.
- Assuming a property qualifies. A home you have lived in, or one you bought to resell quickly, may not qualify. Confirm with your tax adviser before you list.
Your 1031 exchange checklist
- Talk with your tax adviser about whether an exchange fits your goals, including any California requirements.
- Choose a qualified intermediary and sign the exchange agreement before your sale closes.
- Get a current valuation of the property you are selling.
- Decide what you want the replacement property to do for you, such as steadier income, a longer hold or less day-to-day management.
- Start touring and evaluating replacement properties before your sale closes. You can browse current listings any time.
- Mark day 45 and day 180 on your calendar the day your sale closes, and share both dates with everyone involved.
- Identify your replacement properties in writing, following your QI's instructions.
- Close on the replacement property inside your 180 days.
If you are considering an exchange, reach out early, ideally months before you list. We will build the plan around your tax adviser and QI. You can meet the people who will work with you on our team page.
This guide describes our general process. It is not legal, tax or lending advice.
Frequently Asked Questions
Can I use a 1031 exchange when I sell the home I live in?
Generally, no. A 1031 exchange applies to real property held for investment or business use. Your primary residence falls under separate tax rules. Your tax adviser can tell you which rules apply to your sale.
How long do I have to find and buy a replacement property?
Under the general federal rules, you have 45 days from the sale of your current property to identify replacement properties in writing, and 180 days from that sale to close, or until your tax return due date including extensions if that comes first. Both clocks start on the same day.
Can I hold the money from the sale until I buy?
No. A qualified intermediary holds the sale proceeds during the exchange. If the money is paid to you, the exchange generally fails. Set up the qualified intermediary before your sale closes.
Does a 1031 exchange mean I never pay tax on the gain?
No. A 1031 exchange defers the tax, which means it is put off until later. It does not erase it. Any cash you receive, or any reduction in your loan amount, can also be taxable. Your tax adviser will explain how this works for you.
Do I still need a tax adviser if I work with The Mashore Group?
Yes. We are real estate agents, not tax advisers. We coordinate the timing of your sale and purchase, find and evaluate replacement properties, and work alongside your qualified intermediary and tax adviser. Every exchange should be set up with both before your sale closes.