1031 Exchange Rules 2024: Info on 1031 Exchange for Beginners

If you came here confused, scrambling on the “1031 exchange rules 2024” Google page for answers, you’ve come to the right place. We’ve pored over the rules to create the definitive 1031 exchange for dummies guide.

That’s right. The 1031 exchange timeline can be thorny to navigate for even the most seasoned real estate investor. However, if you follow the rules, you can maximize your potential for success. Let’s get through it together, step-by-step.

Main Takeaways

• The 1031 exchange is a tax-deferment strategy. It lets you to defer the capital gain taxes you get when selling investment properties. You defer taxes by buying another “like-kind,” or similar, property with the original property’s gains.
• There are four types of 1031 exchanges: simultaneous exchanges, delayed exchanges, reverse exchanges, and construction exchanges.
• 1031 exchanges have two timelines: the 45-day period to find a property to buy and a 180-day period to actually buy it.
• 1031 exchanges have various rules, such as ensuring your acquired property has equal or lesser value as your sold property. The strategies needed to follow these rules are outlined in the below article.

Table of Contents

• What is a 1031 Exchange?
• Why is It Important to Investors?
• Types of 1031-Numbered Exchanges?
• 1031 Exchange Rules 2024: A List
• 1031-Type Exchange Timelines: The Two Types
• Instructions for Following The 1031 Exchange Rules 2024

What Is a 1031 Exchange?

As hard money lenders in North Virginia, we know the 1031 exchange is a tax-deferment strategy real estate investors use to save money. It enables you to defer the capital gain taxes you would face when your investment property is sold. That is, you can defer taxes if you buy another “like-kind,” or similar, property with the original property’s gains.

It’s important to note that tax deferment is not the same as tax forgiveness. Still, if play it smart, you can make it have that effect. Should you continue to buy “like-kind” properties with a rising net market value, you can reinvest your real estate equity over and over without paying taxes on your equity earnings.

Why is It Important to Investors?

With 1031 exchange tax savings, investors can build wealth faster. They can exchange, or reinvest, their property earnings into other lucrative property purchases.

Best of all, you can channel these tax-deferred exchanges into more luxurious properties, properties that diversify your portfolio, or even just properties that serve to delay your tax deduction. You have options.

Types of 1031-Numbered Exchanges

Several kinds of 1031 exchanges exist. These include simultaneous exchanges, delayed exchanges, reverse exchanges, and construction exchanges. We’ll break each one down below.

Simultaneous Exchange

With a simultaneous exchange, you lock your replacement property under contract before or when you finish closing on your initial property. Your first sale’s escrow company can transfer the old funds from one escrow account to the new purchase’s one.

This type of exchange also happens when two parties swap their respective deeds.

Delayed Exchange

This is the most common type of 1031 exchange. It happens when investors surrender their initial property before they move forward with their replacement property. This type of exchange requires a 45-day identification period and a 180-day escrow closure deadline.

Reverse Exchange

With a reverse exchange, investors buy a property for cash with sources like hard money loans. Then, they pinpoint the property they’ll sell in exchange for this new property.

However, a reverse exchange comes with a caveat. It requires investors to exclusively use cash for their purchases until they can apply their 1031 exchange funds. If you don’t follow this rule, you may have to forfeit the exchange completely.

Again, this 1031 exchange timeline gives investors 45 days to find a relinquished property to sell, as well as 180 days to close the sale.

Construction or Improvement Exchange

Construction exchanges give investors the ability to improve their replacement property with their exchange equity. Within the 180-day 1031 exchange timeline, they must spend all their exchange equity on either a home remodel or a down payment.

1031 Exchange Rules 2024: A List

1031 exchanges have strict IRS regulations. You must match certain rules and criteria to qualify for the exchange and its capital gains tax benefits.

The 1031 exchange timeline is notoriously short. Needless to say, no one wants to find their project in the lurch at the last minute. So, investors like you should get acquainted with the following 1031 exchange requirements:

• Must Be Like-Kind Properties

For a replacement property to qualify for the 1031 Exchange, it must be “like-kind.” The term “like-kind” means that a replacement property has a similar nature or characteristics as the original property. It doesn’t refer to the comparable properties’ quality or grade.

Luckily, most kinds of real estate are classified as “like-kind.” For instance, residential rental houses are “like-kind” to multi-unit apartment buildings, vacant land, and even strip malls. Of course, this only applies to “like-kind” properties within the US. Take note of that big asterisk.

• Must Be Investment, Business, or Trade Properties

Furthermore, when you buy properties with 1031 exchanges, you must hold them for investment, business, or trade purposes, not resale or personal use. For example, people’s homes cannot be used.

This holding period generally lasts at least two years after the escrow close. So, if you want to include a rental property that used to be your old home, you must wait until it has been a rental property for two full years.

• Must Be Greater or Equal Value

Your acquired property’s net market value and equity must be equal to or greater than the sold property. More specifically, the acquired property’s value must be a minimum of 95% of the sold property’s value.

For instance, you can exchange one property’s $1,500,000 sale into three properties at $800,000, $300,000, and $600,000 value.

This almost sounds too good to be true, but there’s an explanation. The above example happened because the replacement properties’ total value outdid the original sale’s price. As an aside, you should remember the new property’s total value includes inspections, broker fees, and other costs.

• Taxpayer Names Must Match

The tax return and name on the sold property’s title must match the new property’s tax return and title holder. In other words, the seller must buy their own new property, not a transferring party.

• Cannot Receive “Boot”

Boot refers to exchange value that doesn’t come from your like-kind property. This can include cash, property renovations, or debt relief.

• Reinvest Your Total Equity

You must reinvest all your 1031 exchange’s sold property’s equity into the replacement property. If you don’t use all the equity for this purpose, you could be liable for the uninvested portion’s taxes.

• Stick to Arm’s-Length Transactions

When you sell and buy your 1031 property, each process must be an arm’s length transaction. By this, we mean you aren’t allowed to hold transactions with family, friends, or anyone else you have a personal connection to. This would be a conflict-of-interest.

• Use a Qualified Intermediary

Qualified intermediaries are neutral, third-party entities that keep the transaction funds throughout the 1031 exchange timeline until the replacement property’s seller can take them. After all, if investors take hold of the sales earnings before the replacement property’s closing, the 1031 exchange would fall through.

1031-Type Exchange Timelines: The Two Types

There are two basic timeframes you must pay attention to when doing a 1031 exchange. They’re known as the 45-day identification timeframe and the 180-day purchase period.

45-Day Identification Timeframe

This is the first big step of the 1031 exchange timeline. When the seller’s first property closes escrow, they have 45 days to pinpoint a max of three possible replacement properties of any value.

However, there are exceptions. The three-property limit doesn’t count with the 200% rule, where all properties have less than 200% combined value of the original property’s sale price.

In any case, experts urge investors to submit offers on all their replacement properties and set up their plans as much as they can within that 45-day timeframe.

180-Day Purchase Period

The second part of the 1031 exchange timeline lies within 180 days after the property sale. Here, you must close in on at least one property you’ve got your eyes on. Notably, this period includes the above 45-day period.

This is when you’ll need to secure quick money, such as hard money loans. This way, you can make the purchase deadline in time. As an additional note, you should always consult with a tax expert or other professional throughout your investing journey. This way, you’re set up for success.

Instructions for Following 1031 Exchange Rules 2024

Here, we’ve laid out the best practices you should follow for a productive 1031 exchange timeline. If you stick to the below steps, you can have a smoother experience.

1. Pick a Property to Sell: You should find an investment property that has appreciated in value after the purchase. This way, you can reap the biggest benefits of the 1031 exchange’s tax deferment qualities. If you need financial support in this foundational step, you can use hard money loans to buy your property to sell later.
2. Hire a Qualified Intermediary: Before taking the jump and selling your property, you should hire a qualified intermediary (QI). After all, the IRS forbids you, the seller, from holding the money in the time between the old property’s sale and the new property’s purchase. So, your QI will hold onto the funds throughout this time.
3. Put Your Property on the Market: When your original property sells, your QI should keep all the expense-unrelated earnings. If you send your gains to yourself or your bank account, you won’t be exchange-eligible anymore. It’s important to keep real estate marketing strategies in mind throughout this step.
4. Find Possible Replacement Properties: From your sale date, you’ve got 45 days to pinpoint up to three possible replacement properties of any value. Or, instead, you can do this for unlimited properties with a combined value of no more than 200% of the sold property’s worth. Then, you should file this in writing and send it to the QI.
5. Buy Your Replacement Property: With the 1031 exchange timeline, you have 180 days from your original property’s sale date to finish buying new properties. Like we said before, hard money loans can give you a quick way to achieve this if you need funds within weeks. Then, QI will send the initial sale funds to the replacement property’s seller.
6. File Form 8824 with Your Taxes: The year your 1031 exchange timeline happens, your tax return should include Form 8824. This form will notify the IRS of your exchange and let them know the property you sold and purchased. The IRS’s 1031 exchange rules are strict, so you should follow them to the letter.

Buy Your 1031 Exchange Properties with MHML

This may technically be a 1031 exchange for dummies guide, but if you got this far, you are anything but. You, too, can maximize your ROI if you follow the proper 1031 exchange timeline.

If you need a way to fund properties for a 1031 exchange, hard money loans can be ideal. Hard money loans are known for their efficiency. It’s possible to get them within weeks, as opposed to traditional loans that can take months to receive. This can be a perfect fit for a tight 1031 exchange timeline. Contact us today to ensure you stick to the IRS’s 1031 exchange timeline.