What Is A 1031 Exchange? (in Real Estate)

The 1031 exchange is one of the most powerful tools an investor can have in their arsenal for building wealth in real estate. It can help you improve your passive income, simplify property and asset management, assist with your estate planning, diversify your portfolio, and so much more. So, let’s dive on in to “What Is A 1031 Exchange?” in the real estate world.

Section 1031 of the IRS Tax Code

The 1031 exchange gets its name from section 1031 of the Tax Codes from the Internal Revenue Service (also known as the IRC). This exchange is more commonly referred to as the “like-kind exchange” whereby you can sell the property that you own, defer capital gains taxes, and transfer that cash into a new property. Essentially, it’s a tax break that allows you to kick the can down the road on paying capital gains taxes, which can be as high as 20% on the gain, and keep that cash in play.

An Example of a 1031 Exchange

Let’s walk through a quick scenario to show you how a 1031 exchange might work.

You bought a shopping center for $250,000 10 years ago and today it is worth $1,000,000. If you sold it and cashed out, you’d be responsible for paying 20% taxes on the gain of $750,000 (today’s value minus your initial basis), which would be approximately $150,000 to the government.

However, you have the opportunity to execute a 1031 exchange and keep that $150,000 in cash in play by identifying a new asset. If you buy the next asset right, you’re getting a return on that cash and snowballing your wealth.

There Are Rules!

It’s absolutely critical that you follow all of the rules of section 1031 of the Internal Revenue Code to ensure that you properly qualify for the tax benefits of a 1031 exchange. These rules include:

• Identification timelines

• Valuation guidelines

• Proper use of a qualified intermediary

• And more

The 1031 exchange is great but if you don’t follow these rules to a T, there’s a chance you won’t qualify. Dive deeper into 1031 exchanges here: