1031 Exchange Rules: Eligibility and Requirements
1031 exchange rules are essential to protecting your tax deferral. This guide explains eligibility and compliance so you can invest with confidence with Breakwater Exchange.
1031 Rules: What You Need to Know About Qualifications
Not every real estate sale qualifies for a 1031 exchange, but many do, especially when structured correctly. At a high level, the IRS requires that both the property you sell (the relinquished property) and the one you acquire (the replacement property) be held for business use or investment purposes. This means rental properties, land held for appreciation, and commercial buildings often qualify, while personal residences or property held for resale typically do not.
The phrase “like-kind” is commonly misunderstood. It doesn’t mean you must exchange a retail building for another retail building. Rather, it means the two properties must be similar in nature or character, both being investment or business-use real estate. Properties must also be located within the U.S. to qualify, though some U.S. territories may be acceptable in limited cases. Multiple properties can be sold or acquired within the same exchange, adding flexibility for your reinvestment strategy.
What Are the Requirements for 1031 Eligible Investments?
To receive full tax deferral, you must follow a strict set of 1031 exchange rules and DST requirements enforced by the IRS. Here’s what to know before initiating a transaction:
- Like-Kind Requirement: Both the relinquished and replacement properties must be real estate held for investment or business use. The type doesn’t matter, just the purpose.
- Qualifying Use: Personal residences, fix-and-flip properties, and inventory do not qualify. Only real estate used for investment or business is eligible.
- Time Periods: You have 45 days from the sale of your original property to identify replacement properties, and 180 days to complete the purchase.
- Same Taxpayer Rule: The entity or person who sells the original property must be the same one who acquires the replacement property to qualify for deferral.
- Use of a Qualified Intermediary (QI): To remain compliant, you cannot take possession of the sale proceeds. A QI must hold the funds and facilitate the exchange.
- Maximizing the Deferral: To defer 100% of your capital gains, the new property must be equal to or greater in value, and you must reinvest all equity and replace any debt.
- No Receipt of Exchange Funds: Direct access to the sale proceeds disqualifies the exchange. Funds must go through the QI until the new property is secured.
FAQs About 1031 Exchange Rules
Can I live in a property I acquire through a 1031 exchange?
No. Breakwater Exchange ensures all replacement properties meet IRS requirements by being held strictly for business or investment use. Personal residences are not eligible under 1031 rules.
Is there a limit to how many properties I can identify in an exchange?
Yes, and Breakwater Exchange helps you navigate the identification process with clarity. You may identify up to three properties under the 3-Property Rule or use the 200% or 95% rules for larger portfolios, depending on your goals.
What happens if I can’t close on my replacement property within 180 days?
Breakwater Exchange proactively manages your exchange timeline from day one. If the 180-day window is missed, the exchange fails, and taxes may be due. Our role is to help you avoid that entirely with tailored planning and vetted backup options.
