What is a 1031 exchange | How does it work

A 1031 exchange - referring to section "1031" of the IRS tax code - allows an investor to sell an investment property that he/she currently owns and reinvest 100% of the proceeds to acquire a "like-kind" property of equal or greater value and therefore defer the payment of capital gains taxes. This provision in the tax code dates back to 1921 and can be a significant vehicle for real estate investors to maximize their wealth.

How does an exchange work?

In a tax-deferred 1031 exchange, the property initially being sold is called the “relinquished property” while the new property is called the “replacement property”. The process works as follows:

1. The investor decides to sell a property, finds a buyer, and opens escrow.



2. Ownership of the relinquished property is transferred to a qualified 1031 intermediary or “accommodator”.



3. Escrow closes on the relinquished property and the proceeds from the sale are transferred into an interest-bearing account held by the qualified intermediary. At this point, the investor has 45 days to locate a "replacement property" and 180 days to complete the exchange and close escrow on the replacement property.



4. When the investor is ready to close on a replacement property, the qualified intermediary will transfer the proceeds from the previous transaction into the new escrow account.

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