1031 Exchange Guide
Comprehensive guide to IRC Section 1031 like-kind exchanges for deferring capital gains taxes on investment property sales.
1031 Exchange Timeline Tracker
What Is a 1031 Exchange?
A 1031 Exchange (named after IRC Section 1031) allows real estate investors to defer paying capital gains taxes when selling an investment property by reinvesting the proceeds into a "like-kind" replacement property.
Example Savings:
- • Sell investment property for $800K (purchased for $500K)
- • Capital gain: $300K
- • Federal tax (20%) + MA state (5%) + 3.8% NIIT = $86,400 tax bill
- • With 1031: $0 tax now, full $800K reinvested
Critical Timeline & Rules
Day 0: Close on Relinquished Property
- • Qualified intermediary (QI) holds sale proceeds (you CANNOT touch the money)
- • 1031 exchange officially begins
Day 1-45: Identification Period
- • Must identify replacement property(ies) in writing to QI
- • 3-Property Rule: Identify up to 3 properties of any value
- • 200% Rule: Identify unlimited properties, total value ≤ 200% of relinquished property
- • 95% Rule: Identify unlimited properties, must acquire 95% of identified value
- • Midnight of 45th day is hard deadline (not business days—calendar days)
Day 46-180: Exchange Period
- • Must close on at least one identified replacement property
- • QI transfers funds to close on new property
- • Deadline is 180 days OR tax filing due date (whichever is earlier)
Types of 1031 Exchanges
Delayed Exchange (Most Common)
Sell first, then buy replacement within 180 days. QI holds proceeds during transition.
Best for: Standard investment property swaps
Reverse Exchange
Buy replacement property BEFORE selling relinquished property. QI temporarily holds title.
Best for: Hot markets where you found perfect replacement
Improvement/Build-to-Suit Exchange
Use sale proceeds to improve/build on replacement property. Must complete improvements within 180 days.
Best for: Value-add opportunities, development
DST (Delaware Statutory Trust)
Buy fractional ownership in professionally managed institutional property. Passive investment.
Best for: Retiring landlords wanting passive income
Key Rules & Requirements
✅ Like-Kind Property
Any real estate held for investment/business qualifies. Can exchange:
• Single-family → Multi-family
• Residential rental → Commercial
• Land → Developed property
NOT allowed: Primary residence, fix-and-flip, dealer property, non-US property
✅ Equal or Greater Value
Replacement property must be equal or greater value than relinquished. If you "trade down" or take cash out ("boot"), that portion is taxable.
⚠️ Qualified Intermediary Required
You CANNOT touch the sale proceeds. QI must be in place before closing. Touching the money = disqualified exchange = full tax bill.
✅ Same Taxpayer
Title must be held the same way (individual, LLC, trust, etc.). Can't switch from personal to LLC mid-exchange.
1031 Strategies for Boston Investors
Common Exchange Scenarios:
- Single-Family to Triple-Decker: Sell Newton single-family ($1.2M), buy Somerville 3-unit ($1.3M) for better cash flow
- Aging Landlord to DST: Sell Cambridge 2-family, buy DST fractional ownership in apartment complex—no more tenant calls
- Consolidate Multiple Properties: Sell 3 condos in Quincy, buy 6-unit building in Malden—easier management
- Trading Up Markets: Sell Waltham property, exchange into higher-appreciation Cambridge/Brookline area
Massachusetts Considerations:
- MA recognizes federal 1031 exchanges—no separate state filing
- 45-day deadline is critical in hot Boston market (bidding wars, tight inventory)
- Consider backup properties in identification—properties go under agreement fast
- Out-of-state exchanges allowed (e.g., sell Boston, buy FL)—but watch depreciation recapture rules
Common Mistakes That Disqualify Exchanges
- ❌ Touching sale proceeds (even for 1 day) before QI transfers to replacement
- ❌ Missing 45-day identification deadline (no extensions, even if day 45 is a holiday)
- ❌ Identifying property not actually for sale or unattainable
- ❌ Using replacement property as primary residence immediately after exchange
- ❌ Taking cash out ("boot") without realizing it's taxable
- ❌ Hiring QI after closing on relinquished property (must be before)
Legal & Tax Disclaimer: This guide provides educational information only. IRC Section 1031 is complex and has strict rules. A failed exchange results in full tax liability. Consult a qualified CPA, tax attorney, or 1031 exchange specialist before proceeding. Namaste Boston Homes is not a tax advisor or attorney and does not provide tax or legal advice.
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