1031 Tips: Being Brilliant at the Basics

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Just like in baseball, when planning for a 1031 exchange, understanding certain basics will help you have a successful turn at bat. Being brilliant at the basics will help you hit a home run. With a 1031, your success primarily hinges on having a basic understanding of this transaction and paying attention to certain key factors. To assist you, we have organized this blog in the typical order of an exchange laying out what is most important to know throughout the process to maximize the amazing benefits a 1031 offers. We encourage you to click on the links with each topic to access more in-depth information from our archives.


1. A 1031 exchange only works if the property you are selling and the property you are planning to buy both pass the “qualified use” test. Real estate that is eligible for 1031 treatment includes only property used in a trade or business or held for investment. For example, property that you primarily rent out and depreciate on your tax return would be a qualified use. Property that you only use personally or inventory that you flip is not a qualified use. In short, you cannot do a 1031 on your personal residence, a personal-use second home or property that is considered dealer inventory.

2. If the properties meet the “qualified use” requirement, you can exchange any property for another that is “like-kind”. Any kind of investment real estate is considered to be “like kind” with any other type of investment real estate. As such, you can sell land and buy rental property, or sell apartments and buy an office building.

3. Is there enough taxable gain to defer to justify doing an exchange? To determine the potential gain, you must first know the current adjust basis of the property you are selling. Generally, the beginning basis is what you paid for the property. Over time, the beginning basis is reduced by any depreciation taken and increased by the cost of capital improvements. To arrive at an estimate of the taxable gain, simply subtract the adjusted basis from the net sales price (sales prices less all expenses except the loan payoff). The resulting number should ballpark the taxable gain. (Note: It is always best to contact your accounting professional for assistance with this calculation. They should be able to tell you the exact amount of gain and the potential tax due if you do not opt for a 1031.)  

4. How the property you are selling is titled determines in what name you will need to buy the new property to comply with the “same taxpayer” rule. You must take title to the replacement property in the same name/same taxpayer ID as the property you sold unless you are using a disregarded entity- like a single member LLC whose sole member is the exchanger. Make sure you understand how the property is titled and if complying with this requirement meets your investment goals and objectives.

5. Will what you plan to buy allow you to defer all the gain from the sale? To achieve total gain deferral, you must (1) buy property that is the same price or greater than what you sold and (2) use all of the cash proceeds from the sale. Anything less is a partial exchange and will trigger some tax ramifications.

6.  A partial exchange doesn’t invalidate a 1031.  It is not an “all or nothing” proposition. You can keep some of the proceeds or buy replacement property that costs less than what you sold. You will just have to pay tax on the difference.

7. When planning, remember that your taxable gain is top-end loaded, not prorated based on how much value you replace. If you plan to keep some of the cash or buy a property that is less expensive than the one you sold, you might not benefit from a 1031. You must buy property that costs more than your current tax basis to begin deferring the first dollar of gain. Ask your tax profession for your current adjusted basis in order to accurately assess if a 1031 makes sense for you.

8. Finally, you need to plan for a 1031 and hire a service provider (a “Qualified Intermediary” or “QI”) before you close! Though you can decide to do a 1031 right up to the closing, once you have closed- it’s too late even if you have not taken receipt of the proceeds or cashed the check. Additionally, there are other mandatory requirements that must be met at or before the closing. Once you decide to move ahead with a 1031, hire a QI in adequate time for your transaction to be conducted smoothly.


1. It’s best to have 1031 cooperation language in your contract if possible. While not mandatory, it is best to inform the buyer that you are planning to do a 1031 exchange in your sales contract and get their agreement to cooperate if needed.

2. There are some specific ways to handle earnest money. You can personally receive and deposit the earnest money during the contract period, but you should forward the earnest money to the closing. These funds will become taxable if you still have them after the closing.

3. Coordination with your 1031 QI is key. You will need to sign an Exchange Agreement with your QI, along with other documents. Be sure and send a copy of the fully executed contract and any amendments, closing information and other pertinent details to them well in advance of the closing. The QI will need to send instructions to the closing attorney or agent so that your sale complies with the 1031 regulations.

4. You will have no access to the net proceeds from the sale during the 180-day exchange period, unless you fail to ID property by the 45th. During the exchange period your funds must be held in an account to which you do not have direct access. These funds can only be used to purchase properly identified replacement property or cover expenses outlined in your exchange agreement that are allowed under the IRS Regulations. If you must have funds from the sale before the exchange period ends, the disbursement must be made at the relinquished closing.

5. Once your relinquished property sells, two important timelines start simultaneously. After the sale of the relinquished property you have 45 days to submit an ID Letter and 180 days to complete your exchange. The beginning day of both time periods is the day after the relinquished closing. Once you have ID’ed property, you can only purchase one or more of those identified.


1. The only document that really changes with a 1031 is the closing statement. You may see the QI’s name, signature and a line showing what sales proceeds are being sent to the 1031 bank account. Though your QI will send instructions to the closing agent outlining what is needed, they rarely, if ever, attend the closing in person.

2.  The deed for the property will go directly from seller to buyer as in any transaction. The QI is never in title in a regular exchange.

3.  In order not to trigger unnecessary tax, credits for prorated rents and security deposit transfers, if any, should be “paid outside of closing”-i.e. not reduce the proceeds on the closing statement.

4.  The proceeds will be wired directly to your 1031 bank account. If the closer is about to give you the money/proceeds or you do not see your 1031 service listed on the closing statement —stop and call your QI.



1.  Be sure that you understand the identification rules. You can identify up to 3 properties of any value or any number of properties as long as their combined value doesn’t exceed 2x the price of what you sold. Choose wisely and plan well. Once the ID period has expired, you are limited to only those properties listed as potential replacements.

2. Understand the 45 and 180 day time requirements. You have 45 days in which to identify potential replacement properties and a total of 180 days to purchase them. Both timelines run simultaneously and start on the day following the relinquished sale.

3. Revisit the same taxpayer rule because it governs how you can contract for and take title to replacement property. You must take title to new property in the way you sold the old one unless you use a disregarded entity such as a single member LLC whose sole member is the exchanger. Your contract should show the correct name as the buyer. A married couple is not considered the same person, and as two people, they cannot form a single-member LLC (unless you are in a community property state).

4. Generally speaking, you cannot buy replacement property from a related party. You can sell your relinquished property to a related party, but, with limited exceptions, you cannot buy replacement property from a related party.

5. Understand the limitation on disbursement of exchange funds to avoid misunderstanding. Once an exchange starts, the release of funds from your 1031 account must comply with the very strange IRS Regulations. Read the link above to fully understand these rules. You can request that earnest money be sent from your exchange account, but you will need to provide a fully executed contract and sign some paperwork first. Alternatively, you can post earnest money on your own and get it back at the replacement closing from the closing attorney.

6. Coordinate closely with your QI. Once you have contracted for replacement property, make sure and send a copy of the fully executed contract, closing info and other pertinent details well in advance of the closing. There are many details they must coordinate before the closing in order to have your funds there to close on time.

7.  Beware of potential lending issues when buying residential property. If you apply for a loan in a different name than the exchanger, you will have problems. For example, if the exchanger is a multi-member LLC, the lender may not be able to make a loan to that entity. They may grant you a loan in your personal name, but will require that you now take title personally, which would violate the same taxpayer rule. If you wish to add a spouse to the loan or make application in a different name, speak with your QI.



1.  The QI can only fund replacement properties that were identified by the 45th day. If you were unable to contract for any of the properties listed, but choose another not on your ID letter, the QI cannot send funds per the Exchange Agreement to the closing.

2.  The QI cannot overfund the closing, allowing some funds to be returned to you. You cannot receive exchange funds during the exchange period without potentially invalidating your 1031.

3.  Any additional funds that you need to provide should be sent to the closing agent, who serves as the disbursing agent, not the QI.



1. The IRS has specific rules on when unused1031 funds can be released. If you fail to ID property by the 45th day, then 1031 funds can be released to you on day 46. If you ID property and acquire the property you identified then remaining proceeds can be released. If you ID property and are unable to acquire all the property you have identified, funds cannot be released until after the 180th day. This holds true even if you are unable to purchase any of the properties you ID’ed. If you know you want to keep some of the proceeds then have the amount you want to receive released to you at the relinquished property closing. Interest earned on your account cannot be released until after the completion of the exchange.

2. There are certain documents needed to fill out Form 8824 that reports the exchange to the IRS. These include the HUDs or closing statements at both the relinquished and replacement closings, your ID letter and an accounting of your exchange bank account. You also need to retain your Exchange Agreement, any assignments and notices of assignment, and other relevant documents to support your transaction.

We hope this list will help you reach home plate with the game well in hand. It is a product of 25 years of interaction with clients, and though not comprehensive, should give you a playbook of what to know and look out for as you proceed. Being brilliant at the basics will help you achieve the maximum benefits that a 1031 can offer. As always, you are welcome to contact us if you have questions. We also urge you to consult your tax and financial advisors before proceeding with any transactions.


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