1031 Exchange Checklist

What Is a 1031 Exchange?

A 1031 exchange, also known as a like-kind exchange, allows property owners to sell an investment property and purchase another similar property without immediately paying capital gains taxes on the sale. The IRS permits this tax deferral as long as you follow specific rules and timelines.

The primary benefit is the ability to leverage the full sale proceeds for your next investment, rather than paying taxes that could reduce your purchasing power by 15% to 37% or more, depending on your tax bracket and state taxes.

Types of 1031 Exchanges

Before diving into the checklist, understand the main types of 1031 exchanges:

Delayed Exchange: The most common type, where you sell your property first and then identify and purchase replacement property within specific timeframes.

Simultaneous Exchange: Both properties close on the same day, requiring precise coordination between all parties.

Reverse Exchange: You acquire the replacement property before selling your current property, useful in competitive markets.

Build-to-Suit Exchange: You use exchange funds to improve or construct on the replacement property.

Pre-Exchange Planning Checklist

Confirm Property Eligibility

Your property must meet specific criteria to qualify for a 1031 exchange. Verify that both your relinquished property (the one you’re selling) and your replacement property meet these requirements:

• The properties must be held for investment or business purposes, not personal use
• Both properties must be located within the United States
• The properties must be “like-kind,” meaning they’re both real estate (nearly all real estate qualifies as like-kind to other real estate)
• You cannot exchange personal residences, fix-and-flip properties, or inventory held for sale

Establish Investment Intent

Document that you’ve held your current property for investment purposes. The IRS doesn’t specify a minimum holding period, but most experts recommend holding property for at least one to two years to demonstrate investment intent. Keep records of rental agreements, property management activities, and financial statements.

Choose a Qualified Intermediary

Select a qualified intermediary (QI) before listing your property for sale. A QI is an independent third party who holds the sale proceeds and facilitates the exchange. This step is crucial because if you receive the funds directly, the exchange is disqualified.

When choosing a QI, consider their experience, bonding and insurance coverage, fees, and reputation in the industry. Interview multiple qualified intermediaries and verify their credentials and financial stability.

Consult Tax and Legal Advisors

Engage a CPA familiar with 1031 exchanges and a real estate attorney to review your specific situation. They can help you understand tax implications, assess whether a 1031 exchange makes sense for your goals, structure the exchange properly, and identify potential pitfalls.

Calculate Financial Requirements

Determine the minimum investment needed for your replacement property. To defer all capital gains taxes, you must purchase property of equal or greater value than your relinquished property and reinvest all equity from the sale.

Calculate your expected net proceeds from the sale, minimum replacement property value needed, and additional capital required if purchasing a more expensive property.

Property Sale Checklist

Notify Your Qualified Intermediary

Contact your QI before listing your property or accepting any offers. They will prepare the necessary exchange documents and coordinate with your closing agent.

Include Exchange Language in Sales Contract

Your purchase and sale agreement must include specific language indicating your intent to complete a 1031 exchange. Your QI typically provides this language, which protects your right to assign the contract to the QI and notifies the buyer of the exchange structure.

Coordinate the Closing

At closing, the sale proceeds go directly to your qualified intermediary, not to you. Review closing documents before signing to confirm they reflect the 1031 exchange structure and ensure the QI receives all funds.

Do not take constructive or actual receipt of the proceeds, as this will disqualify your exchange. Even temporary possession of the funds invalidates the tax deferral.

45-Day Identification Period Checklist

The clock starts ticking the day after your relinquished property closes. You have exactly 45 calendar days to identify potential replacement properties in writing to your qualified intermediary.

Understand Identification Rules

The IRS provides three identification rules, and you must follow at least one:

Three-Property Rule: Identify up to three properties of any value.

200% Rule: Identify any number of properties as long as their combined fair market value doesn’t exceed 200% of the relinquished property’s sale price.

95% Rule: Identify any number of properties of any total value, but you must acquire 95% of the identified value.

Most investors use the three-property rule for its simplicity and flexibility.

Create Your Identification List

Begin searching for replacement properties immediately after closing. Work with real estate agents familiar with 1031 exchanges and tour potential properties quickly.

When identifying properties, provide the complete legal address or legal description of each property and send written notice to your QI before midnight on the 45th day. Use certified mail or another method that provides proof of timely delivery.

Consider Backup Properties

Market conditions can change quickly, so identify backup options if possible. Properties may go under contract to other buyers or fail inspections, so having alternatives protects your exchange timeline.

Document Everything

Keep detailed records of your property search activities, correspondence with your QI, and copies of identification notices sent. This documentation proves compliance if the IRS ever questions your exchange.

180-Day Exchange Period Checklist

You have 180 calendar days from the closing of your relinquished property to close on your replacement property. This deadline cannot be extended and runs concurrently with the 45-day identification period.

Begin Due Diligence Immediately

Start inspections, appraisals, and title work as soon as you identify properties. Order property inspections and environmental assessments, review title reports and resolve any issues, secure financing if needed, and negotiate purchase terms.

Coordinate with Your Qualified Intermediary

Maintain regular communication with your QI throughout the purchase process. They need to prepare exchange documents for the replacement property closing and coordinate with the closing agent to ensure proper fund disbursement.

Meet Replacement Value Requirements

To defer all capital gains, your replacement property must be equal or greater in value to your relinquished property, and you must reinvest all net proceeds from the sale. Any cash or value you receive (called “boot”) will be taxable.

If you can’t find a single property that meets your needs, consider purchasing multiple properties. The IRS allows you to exchange one property for several replacement properties.

Complete the Purchase

At the closing of your replacement property, your qualified intermediary will transfer the exchange funds directly to the closing agent. Review all closing documents to confirm the exchange structure is properly documented and ensure no proceeds are distributed directly to you.

Post-Exchange Checklist

Maintain Investment Intent

Continue operating your replacement property as an investment. Rent the property to tenants, maintain appropriate insurance coverage, and keep detailed financial records.

Avoid converting the property to personal use immediately after the exchange, as this could trigger IRS scrutiny and potential tax consequences.

File Tax Returns Properly

Report your 1031 exchange on your federal tax return using IRS Form 8824, “Like-Kind Exchanges.” Your CPA should prepare this form, which details the relinquished property, replacement property, dates of sale and purchase, and deferred gain.

File Form 8824 for the year in which you sold your relinquished property, even though the replacement property purchase may occur in the following calendar year.

Retain Records

Keep all 1031 exchange documentation for at least seven years, including exchange agreements with your QI, identification notices, closing statements for both properties, Form 8824, and correspondence with your QI and advisors.

These records are essential if the IRS audits your return or if you complete another 1031 exchange in the future.

Common Mistakes to Avoid

Even experienced investors make errors that can disqualify a 1031 exchange or result in unexpected tax liability. Avoid these common pitfalls:

Missing Deadlines: The 45-day and 180-day deadlines are absolute and cannot be extended for any reason, including weekends, holidays, or natural disasters.

Taking Receipt of Funds: If you receive sale proceeds directly, even temporarily, your exchange is disqualified immediately.

Improper Identification: Failing to identify properties in writing, missing the 45-day deadline, or not following one of the three identification rules disqualifies your exchange.

Not Meeting Value Requirements: Purchasing a less expensive replacement property or not reinvesting all proceeds results in taxable boot.

Using Property for Personal Use: Converting the replacement property to personal use too quickly after the exchange may indicate lack of investment intent.

Choosing an Inexperienced Qualified Intermediary: An incompetent or fraudulent QI can jeopardize your exchange and your funds.

Final Considerations

A 1031 exchange is a sophisticated tax strategy that requires meticulous planning and execution. While the process may seem complex, the tax savings can be substantial, allowing you to build wealth more efficiently through real estate investment.

The key to success is preparation and working with experienced professionals who understand 1031 exchange requirements. Start planning early, understand the timelines and rules, maintain clear documentation, and don’t hesitate to seek professional guidance.

By following this comprehensive checklist, you can navigate the 1031 exchange process with confidence and defer capital gains taxes while growing your real estate portfolio. Remember that tax laws and regulations can change, so always consult with qualified tax and legal professionals before proceeding with any exchange.

Whether you’re completing your first 1031 exchange or your tenth, this checklist serves as a valuable reference to ensure you meet all requirements and maximize the benefits of this powerful tax-deferral strategy.