Posted on Friday, January 21st, 2022

business propertiesWhat is the 1031 exchange?

The 1031 exchange is a popular tax strategy and exchange that occurs when you are selling one investment property in order to purchase another one.

How does a 1031 exchange work?

The first thing you need to understand about the 1031 exchange is that it is generally for investment or business properties only. The 1031 exchange can be a complex process, and the Internal Revenue Code Section 1031 can be very confusing, so you may want to consult an experienced professional. Here is a list of the basic steps of this process:

  • Identify what property you want to purchase or sell. It is important to remember that the 1031 exchange is for investment and business properties only.


  • Choose a qualified intermediary. A qualified intermediary is a professional who will facilitate an Internal Revenue Code Section 1031 tax-deferred exchange. Generally, he or she will prepare the documents necessary to structure the 1031 exchange, hold the funds from the relinquished property until you close on the replacement property(ies), use the funds from the relinquished property to purchase the replacement property(ies), and ensure that the exchange is completed in compliance with the Internal Revenue Code. It is important to choose an intermediary carefully because if they don’t follow the process correctly, you may lose money.


  • Find a buyer for the property you are selling. The next step is finding a person interested in purchasing the property you intend to relinquish in the 1031 transaction. Once you find someone who is interested in purchasing the property, you will enter into a Purchase & Sale Agreement with the buyer.


  • Make sure to add a special clause in your Purchase and Sale Agreement. A special clause will need to be inserted in the purchase and sale agreement which discloses to the Buyer that the Seller intends to use the transaction as a part of a 1031 tax-deferred exchange and that the Buyer agrees to cooperate with the Seller in order to accomplish the 1031 tax-deferred exchange. You can draft your agreement and add a clause in the agreement yourself, or you can hire a Florida real estate lawyer, who will help you with that and will ensure that it is drafted properly.


  • Enter an exchange agreement. You will enter into an agreement with your qualified intermediary. The agreement will likely state that you are assigning the Seller’s rights for the relinquished property and the Buyer’s rights for the new replacement property to the qualified intermediary. Your qualified intermediary will be able to act on your behalf without your direct control of the funds during the exchange process.


  • Identify the property you want to purchase. You will have to identify which property or properties you are interested in purchasing with the proceeds you received from the sale of the relinquished property. You can identify up to three potential replacement properties under the 3-property rule, and you can identify as many properties as you would like under the 200% rule. These rules can get quite complex, so it is important to confer with a real estate attorney on this so that you can ensure that the process is followed correctly. If it is real property, you will need to provide the name and the address of the property. You will have 45 days after the sale of your relinquished property to identify a new replacement property(ies).


  • Ensure that all timelines are properly followed. According to the exchange agreement, your intermediary will use the funds received from the sale of the relinquished property to acquire the replacement property. The exchange must be completed within 180 days. It is important to point out, this is not within 180 days from the date that the replacement property is selected. It is actually 180 days from the date of the sale of the relinquished property, so it is important to ensure that any purchase of replacement property is completed before then.


  • File IRS Form 8824. The IRS Form 8824 is used to report an exchange of real property. You must complete and submit the IRS Form 8824 to the IRS in order to receive the tax-determent benefit of your exchange. If you are doing an exchange in Florida, it may be a good idea to consult a qualified Central Florida real estate lawyer.


Nishad Khan P.L. – Professional Legal Help for Investors In Central Florida

The 1031 exchange can be a very complicated process, especially for first-time investors. Also, the implications for not following the process correctly can result in additional tax liability to the investor. Therefore, if you have never completed a 1031 exchange, you may need the professional help of an experienced real estate attorney. If you considering participating in a Florida 1031 Exchange, and you want to make sure that you are doing everything right, contact our Florida real estate law firm and schedule a consultation with our Central Florida real estate attorney. Do not hesitate to visit our website or to give us a call – we are always here for you.