What is a tax deferred 1031 exchange?

Posted on November 28, 2023 By: Jerry Feeney

What is a tax deferred 1031 exchange?

A deferred 1031 exchange is a tax-savvy strategy provided by the Internal Revenue Code, that allows real estate investors to defer capital gains and depreciation recapture taxes when sell and the buy investment property. This can be a valuable and powerful tool for investors looking to accumulate wealth, who are looking to upgrade or diversify their portfolio.  However, the rules must be followed carefully.


Tax deferred 1031 exchanges are known by several names: forward exchange, delayed exchange, like-kind exchange or simply a 1031 exchange. There are also different types of exchanges within these categories, for example, improvement and reverse exchanges.  But for this article, we will discuss the most common, which is a delayed or Starker exchange.


How does a Starker delayed 1031 exchange work?

To complete a delayed exchange, the investor must first identify a qualified intermediary to facilitate the exchange.  The intermediary holds the proceeds from the relinquished property (sold) until the replacement property (purchased) is ready to be bought.  The purchase is then funded with the proceeds from the sale, and a fee is typically charged for the service.


What is the time limit for a delayed 1031 exchange?

From the date of the relinquished property closing the investor then has 45 days to identify their replacement properties and 180 days to close on these identified properties. There are identification rules to follow. If the investor does not meet these deadlines, the exchange will not qualify for tax deferral, and the exchange will fail.


Why would an investor want to use a 1031 tax deferred exchange?

There are several benefits to completing a deferred 1031 exchange. The most obvious benefit is that by deferring taxes, it keeps a significant amount of money at the use of the investor to increase their purchasing power when selecting a replacement property. In addition, a 1031 exchange can allow investors to:

  • Upgrade their properties to more desirable locations or types of properties without having to remit the gain and depreciation recapture taxes in the year of the sale
  • Diversify their portfolio by investing in different types of real estate (as long as the property is intended to be used as investment property)
  • Consolidate their holdings into fewer, larger properties if they wish


How long can I defer taxes in a 1031 exchange?

If an investor acquires the exchanged property for business, investment or trade use and continues ownership, the taxes can be deferred indefinitely. There is no limitation on continuing to execute exchanges throughout one’s lifetime, but it is recommended to hold a property for the minimum of 1-2 years before executing another exchange on the same property, as section 1031 is only available for long term gains. There are also currently benefits for estate planning using 1031 exchange during your lifetime, which taxpayers can review with estate planning tax advisors to determine what tax liability your estate would have in connection with the sale of property that was the subject of a 1031 exchange during your lifetime and then bequeathed to your beneficiaries on death.


There are many other rules to follow, but overall, a deferred 1031 exchange can be a valuable tool for real estate investors who are looking to defer capital gains taxes and reinvest their proceeds in other investment properties. However, it is important to consult with a tax advisor, and qualified intermediary to ensure that the exchange is completed correctly, and that the investor is eligible for tax deferral.


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