What is a 1031 Exchange?

Below is the step-by-step process to carry out a 1031 exchange. The following is just a general outline, so specific deals will likely vary slightly from this process.

1. Decide to sell and do a 1031 exchange

Not every purchase is worth doing a 1031 exchange. After all, with all the requirements, costs, and countdown timers, it may be advantageous to simply pay the tax and move on. That is definitely a discussion to have with an accountant or tax adviser.

2. List the property for sale

The property for sale will be listed and the agent will likely include language in the listing paperwork regarding the seller’s desire to do a 1031 exchange and the buyer’s needed willingness to go along with the process.

3. Begin looking for replacement properties

Remember, the moment the relinquished property is sold, the countdown of 45 days begins. Therefore, the investor should begin looking for deals immediately.

4. Find a qualified intermediary

The investor needs to look for someone professional with a good reputation.

5. Negotiate and accept an offer

When someone agrees to buy the property, the paperwork must clearly state that a 1031 exchange is taking place on the seller’s end and the buyer will need to comply. Although there is not a lot of work for the buyer to do, there may be paperwork they need to sign off on, such as assignments or disclosures.

6. Close on the sale of the relinquished property

The title company or attorney will handle the closing like any other real estate transaction, except the seller’s qualified intermediary will be actively involved in the process. And the funds will transfer to the intermediary’s bank account, not the sellers.

7. Identify up to three properties within 45 days

It’s now time to officially designate the properties that are under consideration. Keep in mind, up to three properties can be identified, but buyers are required to purchase 95% of the identified properties—or the total combined value of the identified properties is less than 200% of the sales price of the relinquished property.

8. Sign contract on the first-choice property

Most likely, of the three properties identified, one will stand out as the first choice. The buyer will need to get that property under contract and open escrow, making sure the seller knows that the purchase is through a 1031 exchange. Buyers can also go under contract on all three of the identified properties and use contingency clauses to back out on the properties the buyer chooses not to pursue.

9. Let the qualified intermediary work with the title company

The buyer, agent, and qualified intermediary will work with the title company or closing attorney to make sure all the i’s have been dotted and t’s have been crossed. This is a fairly simple process that any qualified intermediary should be familiar with.

10. Close on the replacement property

Finally, the qualified intermediary will wire over the money to the title company or attorney. The property will close like a normal transaction, deferring the buyer’s need to pay the taxes until some point in the future, if ever. (Read on to find out more about the “end game” in a moment.)

The beauty of the 1031 exchange is the ability to repeat this process over and over again on properties and continue deferring taxes indefinitely. This can help build some serious wealth over time, greater than simply paying the taxes each time. One of the greatest benefits of the 1031 exchange is faster wealth growth.