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How A 1031 Exchange Works

Here is an overview of how a 1031 exchange works:

1. A property seller must identify in writing their intent to do a 1031 exchange prior to the closing on the relinquished property. At the closing of the first property the seller includes the exchange language in the buy-sell agreement. This is very important because if you have already sold the property and received any money you will not qualify to do a 1031 exchange.

2. At the closing, sales proceeds must go to a Qualified Intermediary (QI) and are held in a separate account for the benefit of the seller.

3. At this point the seller has 45 days to identify properties for the potential 1031 exchange. This involves written notification to your QI listing the properties’ addresses and/or legal descriptions of the potential replacement properties.

4. The seller has up to 180 days from the closing of the relinquished property to actually complete the purchase of the identified replacement property(s).

5. To fully defer tax on your capital gain, you must purchase replacement property that is of the same or greater value as the property that has been sold. You can do a partial exchange but with a partial exchange you may be subject to tax.

6. To fully defer tax, you must also have the same or greater amount of debt on the new property as the relinquished property. The seller can offset the amount of debt obtained on the replacement property by putting in additional cash in an amount that would be the equivalent to that of the debt.

Exchange Process

Summary Of 1031 Exchange Process

Here is a summary of the 1031 delayed exchange process:

  • The taxpayer arranges for the sale of their relinquished property.
  • At closing, sales proceeds go to a Qualified Intermediary.
  • The taxpayer identifies, in writing, potential replacement properties within 45 days of closing on the relinquished property.
  • The taxpayer closes on the replacement property(ies) and completes the exchange within 180 days of closing on the sale of the relinquished property.

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