Frequently Asked Questions About 1031 Exchanges – Expert Answers from Accruit
As a leading Qualified Intermediary specializing in 1031 Exchanges, Accruit receives daily inquiries about tax-deferred real estate transactions and related considerations. To support investors and property owners, our experienced team of real estate professionals and 1031 specialized attorneys compiled a comprehensive list of the most frequently asked questions about 1031 Exchanges. This resource is designed to clarify key concepts, IRS regulations, and best practices for successfully completing a 1031 Exchange.
General 1031 Exchange Questions
What is a 1031 Exchange?
It’s a tax rule that lets people who own real estate for business or investment purposes defer, or delay, paying taxes when they sell a property, as long as they use the money to buy another similar like-kind property.
Find a more in-depth explanation here What is a 1031 Exchange? – Accruit.
Am I eligible for a 1031 Exchange?
Anyone who pays taxes in the U.S. can do a 1031 Exchange. That includes:
- Individuals
- Partnerships
- LLCs
- Corporations (S and C)
- Trusts
You don’t have to be a U.S. citizen, just a U.S. taxpayer. Even DACA recipients and foreign companies that pay U.S. taxes can qualify.
Important rule: Same Taxpayer
The person or entity that sells the property must be the same one that buys the new property. This doesn’t always mean the name on the title has to match, it’s about the tax identity. For example, if you own a property through a single-member LLC or a trust, it still counts as you for tax purposes because they are disregarded entities.
Is my property eligible for a 1031 Exchange?
Properties must be held for Business or Investment Use. Both the property you sell, the Relinquished Property, and the one you buy, the Replacement Property, must be used for business or investment, not personal use. So, your primary home doesn’t qualify for a 1031 Exchange. While you don’t have to replace a property with exact same type property; the key is that both properties are used for business or investment, not personal use. Learn more about qualified use requirements.
What is the timeline for a 1031 Exchange?
When you do a 1031 Exchange to defer paying associated taxes on a property sale, there is a strict timeline you must follow:
Total Time: 180 Days
You have 180 days to complete the entire exchange, no matter what type it is Forward, Reverse, Build-to-Suit, or Improvement. (See types of exchanges to learn more about the differences)
- Day 0: You sell your Relinquished Property.
- Day 45: You must have identified the new property, Replacement Property, you want to buy.
- This must be in writing.
- It must clearly describe the property.
- You must sign it and send it to your Qualified Intermediary (QI).
- Day 180: You must have closed on the new property.
Find more information about timelines and identification here 1031 Exchange Timeline and Identification Requirements.
Are there rules for a 1031 Exchange?
Yes, there are key rules to completing a 1031 Exchange.
- Properties Must Be Exchanged (Not Just Bought and Sold) You can’t just sell one property and buy another later and call it a 1031 Exchange. To qualify, the IRS needs to see it as a true exchange. To do this, you must use a Qualified Intermediary (QI), a middleman who handles the money and paperwork to link the sale and purchase together. Important: You must set this up before the sale, or purchase in a Reverse Exchange. If you wait until after, it’s too late.
- No Touching the Money – You’re not allowed to receive or control the money from the sale. That’s why the QI is so important, they hold the money and use it to buy the new property. If you or your agent touches the money, even for a moment, the exchange is disqualified and you’ll owe taxes.
- Properties Must Be “Like-Kind” – This means you must exchange one type of qualifying real estate for another qualifying property. But the good news is that almost all real estate is like-kind to other real estate, as long as both are used for business or investment. See below for examples of like-kind property.
- Exchange Equal or Greater in Value – For full tax deferral, you must reinvest all the money from the sale of your property. The new property must cost the same or more than the one you sold.
Are there different types of a 1031 Exchange?
Yes, there are several types of 1031 Exchanges. While the Internal Revenue Code §1031 primarily covers conventional like-kind exchanges, there are many variations and related transactions that fall under or alongside this category. These include Reverse Exchanges, Build-to-Suit or Improvement exchanges, and more. Additionally, some transactions may not be explicitly defined by the tax code but are still commonly used in practice.
See the Types of Exchanges section below to learn more.
Types of Exchanges
What is a Forward or Deferred 1031 Exchange?
A forward 1031 Exchange is the classic 1031 Exchange option, it means you sell one investment property and buy another without paying associated taxes right away. Here’s how it works step by step:
Set Up the Exchange First
Before selling your property, you make an agreement with a company called a Qualified Intermediary (QI). This company helps handle the exchange.Sell Your Property
You give the QI the right to sell your property. The QI sells it and holds the money from the sale in a segregated bank account. You don’t touch the money directly, this keeps the exchange tax-deferred.Identify New Property(ies) (45 Days)
After the sale, you have 45 days to choose the new property, or properties, you want to buy.Buy the New Property(ies) (180 Days)
You must complete the purchase(s) within 180 days of selling your old property.
You negotiate the deal, sign the purchase contract, and then give the QI the right to buy the new property for you.Complete the Exchange
The QI uses the money from the sale to buy the new property. The property is then transferred to you, and the exchange is complete.
See A Primer on 1031 Exchanges and Related Types of Exchanges for more information on types of exchanges.
What is a Reverse Exchange?
A Reverse Exchange, also referred to as a Parking Exchange, is the opposite of a traditional, Forward 1031 Exchange. In this case, you buy the new property first, then sell your old one.
Here’s how it works step by step:
Buy First, Sell Later
You find and agree to buy your new investment property before selling the old one.Use a Special Purpose Entity (SPE)
Since you can’t own both properties at the same time during a 1031 Exchange, a SPE sets up a special company called an Exchange Accommodation Titleholder (EAT) that will temporarily hold the new property for you. This company is usually set up as a single-member LLC just for your exchange.Funding the Purchase
The funds for the purchase of the new property will go to the EAT so it can buy and “park” the property.Complete a Forward Exchange Once the new property is parked, you sell your old property like in a regular 1031 Exchange.
Learn more about reverse exchanges here Are 1031 Reverse Tax Deferred Exchanges of Real Estate Approved by the IRS?
What does Build-to-Suit mean in a 1031 Exchange?
Build-to-Suit refers to a type of exchange when the Exchanger acquires a property that they desire to improve via construction using Exchange Funds. Build-to-Suit refers to exchanges with new construction, whereas an Improvement Exchange refers to exchanges in which construction or improvement will be made to existing structures— although sometimes the terms are used interchangeably.
Watch this video to find out more about Build-to-Suit and Improvement Exchanges Video: What is a Leasehold Improvement Exchange?
What is a Non-Safe Harbor transaction?
A transaction is considered Safe Harbor when it is within the set of guidelines set forth by the Internal Revenue Code that guarantees a valid exchange.
A Non-Safe Harbor (NSH) transaction is a transaction that is outside of the guidelines, due to being longer than the 180-day exchange period. These do not provide the Exchanger with the certainty of a valid Exchange should the transaction be audited.
Read more about Safe Harbor vs Non-Safe Harbor
What qualifies as like-kind property?
One of the advantages of exchanging real estate is that almost all real property is considered like‐kind to all other real property. Since real estate must be exchanged for real estate, the rules provide that “like-kind” references the nature or character of the property and not its class or quality. Common types of properties used within a 103 Exchange include:
- Commercial properties
- Multifamily rentals
- Vacant land
- Single-family rentals
- Vacation rentals (Airbnb/VRBO)
- Farm and Ranchland
- Industrial buildings and warehouses
- Oil, gas, and other mineral interests
- Water and mineral rights
- Cell tower, billboard, and fiber optic cable easements
- Conservation easements
- Delaware Statutory Trusts (DSTs)
The regulations do require that Replacement Property be located within the same geographic location as the Relinquished Property. For a 1031 Exchange, there are only two geographic locations, within the US and outside the US. For example, an Exchanger cannot use proceeds from a property in Ohio to acquire an investment property in Peru. Property within the US is only like-kind to other property within the US, and property outside of the US is only like-kind to other property outside the US.
Advanced 1031 FAQs
At Accruit, we specialize in complex tax deferral strategies that help preserve wealth, grow investments, and support long-term financial wellbeing. Our expert guidance is powered by highly credentialed subject matter experts, enabling us to navigate even the most nuanced 1031 exchange scenarios. Below, you’ll find insights on advanced 1031 topics.
1031 Exchange Expenses
What are valid 1031 Exchange expenses?
When selling or purchasing an investment property in a 1031 Exchange, certain selling expenses paid out of the sales or 1031 Exchange proceeds will result in a taxable event for the Exchanger, whereas other expenses can be paid from Exchange Funds without creating a taxable event.
Allowable closing expenses, include:
- Real estate broker’s commissions, finder, or referral fees
- Owner’s title insurance premiums
- Attorney or tax advisor fees related to the sale or the purchase of the property
- Closing agent fees (title, escrow, or attorney closing fees)
- Recording and filing fees, documentary, or transfer tax fee
Closing expenses that will result in a taxable event, include:
- Pro-rated rents
- Security deposits
- Utility payments
- Property taxes and insurance
- Association’s dues
- Repairs and maintenance costs
- Insurance premiums
- Loan acquisition fees
Learn more about Qualified Exchange Expenses here.
Can I take cash out of a 1031 Exchange?
Exchangers sometimes wish to take some cash out of the Exchange Funds when selling the Relinquished Property as the first leg of an exchange. The cash should be taken at the time of the closing, not after the net proceeds are sent to the Qualified Intermediary. Any cash taken by the Exchanger at closing will be subject to taxation.
How much does a 1031 Exchange cost?
In order to ensure your 1031 Exchange is compliant with the tax code the use of a Qualified Intermediary (QI) is advised. For this reason choosing a reliable and trustworthy QI is important.
When choosing a QI to facilitate your 1031 Exchange, it is essential to exercise due diligence, while there are many Qualified Intermediaries out there, not all are created equal. Accruit is proud to offer boutique-style service across a large volume of exchanges, with the expertise to service all types of exchanges from simple to the most complex.
Because each 1031 Exchange is different, pricing is based upon several factors including the structure required to achieve tax deferral. We begin with an initial consultation to understand the clients’ needs and then prepare a customized quote. To inquire about pricing for your 1031 Exchange reach out to our experts here Contact – Accruit
Can I, as Seller, or my attorney hold earnest money prior to the closing of the Relinquished Property?
Yes, that does not cause any issues since the exchange rules do not come into play until the time the Relinquished Property is transferred. At, or after, that time neither the Exchanger nor his/her agent can be in actual or constructive receipt of the Exchange Funds.
Financing
Do I need specific financing for a 1031 Exchange property?
No, specific financing is not needed for a 1031 Exchange property, in fact, even Seller Financing works.
In the less common instance when a Reverse Exchange is needed, there are additional financing considerations that require advanced planning due to the fact that the loan has to be made to an LLC owned by the Accommodator.
Can property improvement costs be part of a 1031 Exchange?
Yes, in situations where the Relinquished Property sells for a greater value than the Replacement Property, it is possible for construction or improvement costs to reduce the taxable amount. Read Can Property Improvement Costs Be Part of a 1031 Tax Deferred Exchange? for an in-depth explanation of Build-to-Suit and Property Improvement exchanges.
Can the Seller finance the Buyer in a 1031 Exchange?
In situations where the Exchanger and Buyer desire to allow Seller Financing this can work as part of a 1031 Exchange. However, it is more complicated than a sale transaction not involving Seller Financing and requires careful planning with the Qualified Intermediary. Seller Financing is also possible when the Exchanger is receiving the financing in connection with the Replacement Property. The portion financed constitutes debt for the Exchanger that would off-set debt paid off upon sale of the Relinquished Property. We’ve described this in more detail in Seller Financing in a 1031 Tax-Deferred Exchange.
Can I refinance the Relinquished Property after the exchange?
While there is nothing in the Regulations on this question, for technical reasons it is considered bad practice to refinance in anticipation of entering into an exchange. By doing so, it changes the amounts on cash and debt that would need to be applied to the Replacement Property acquisition, and it is equivalent to “gaming the system”. Refinancing after an exchange to pull some equity out does not have these issues and is considered a better practice. Learn the best practices for refinancing in a 1031 Exchange in this blog post Cash out Refinance Before or After a 1031 Exchange.
Related Parties
What is the Related Party Rule?
Since 1921, Section 1031 has allowed Exchangers to defer capital gains taxes when reinvesting in similar property. The idea is that if the investment continues, there’s no need to tax it yet.
However, in the past some tried to abuse this by using Related Parties—like subsidiaries—to shift the basis in the property and avoid taxes. For example, one company could exchange property with a related company. The related company would likely have a significantly higher basis in the property, and it could sell the property with little or no tax due. This was seen as a loophole.
To stop this, Congress added Related Party Rules. If either party sells the exchanged property within two years, the tax deferral is reversed, and both must recognize the gain.
Learn more about the Related Party’s rule and who is considered a Related Party here 1031 Exchange Related Party Rules and Constructive Ownership
Can I buy a Replacement Property from my relative such as son-in-law or cousin?
Yes, the Related Party Rules do not include all relatives. Rather they disallow persons that are descendants to each other. Lineal descendants such as parent, child, grandparents, siblings are considered related for this purpose; in-laws, aunts, uncles, cousins, etc. are not considered Related Parties in the context of 1031 Exchange rules. See 1031 Tax Deferred Exchanges Between Related Parties for full information on what constitutes a Related Party.
Is the exchange invalidated under the Related Party Rules if I sell the Relinquished Property to a Related Party?
No, the purpose of adding the Related Party Rules to the Tax Code was to prevent Exchangers from manipulating the tax result by buying Replacement Property from a Related Party such as a subsidiary company. That so called tax abuse is not applicable when a party is selling the Relinquished Property to a Related Party.
Learn the Exceptions and Misconceptions around related Related Part Rules here.
Is the Related Party Rule cured if both parties hold onto the properties for at least 2 years?
No, this is a misconception. The two-year curative provision only applies if the Related Parties are exchanging directly with one another. This is seldom the case. In a situation where the Exchanger sells the Relinquished Property to a third party and acquires and holds Replacement Property for an excess of two years from the Related Party, that is not sufficient to meet the rule.
Learn the Exceptions and Misconceptions around related Related Part Rules here.
Reverse Exchanges
In a Reverse Exchange, how is it determined whether to park the Replacement Property or the Relinquished Property?
As a rule of thumb, it is generally easier to park the Replacement Property. However, when the Exchanger has financing set up for the Replacement Property that the lender will not allow to be in the name of the Accommodator, this cannot be done. There may be other reasons as well such as known environmental issues on the Replacement Property. These situations might make a Relinquished Property parking the necessary option.
If I am doing a Reverse Exchange do I still need a conventional Forward Exchange?
Yes, many people think if they are doing a Reverse Exchange, that is an alternative in lieu of the Forward Exchange. That is not correct. The only thing a Reverse Exchange does is to allow the Exchanger to effectively purchase the Replacement Property when the corresponding Relinquished Property cannot be sold first. A Forward Exchange is still necessary to exchange the old property for the new property.
For a Reverse Exchange are a double set of real estate taxes applicable when there is an extra conveyance of title?
The IRS issued a ruling years ago that said for purpose of the Exchange Accommodation Titleholders (EAT) role in holding and transferring property in a Reverse Exchange, it could be considered the agent of the Exchanger and as a result extra transfer taxes did not need to be paid. There are a few states that still require payment regardless of the IRS ruling.
Learn the full process and IRS ruling here Are 1031 Reverse Tax Deferred Exchanges of Real Estate Approved by the IRS?
In a Reverse Exchange, do I have to get those funds being lent to the Accommodator prior to closing?
The IRS rules allow the Exchanger to lend the necessary funds to the Accommodator, but just like a bank lending funds, those funds are typically provided directly to the settlement agent and do not need to come to and through the Accommodator.
Check out an example of a Reverse Exchange to help better understand the process.