How a 1031 exchange works
The name comes from Section 1031 of the Internal Revenue Code. The basic rules, based on the IRS's Form 8824 instructions, are:- Real property only. The property you sell and the one you buy must both be real estate held for business or investment. Examples include a rental house, a rental condo or townhome, or a small apartment building.
- Not your home. The rules do not apply to property used solely as your personal residence. Home sellers may have a separate tax exclusion, so ask your CPA.
- Not property held for sale. Real estate held primarily for sale, such as a home you bought to flip, does not qualify.
- You do not touch the money. A qualified intermediary holds the sale proceeds and uses them to buy the replacement property. You, your relatives and your agents cannot serve as the intermediary.
- Cash you take out is taxable. If you receive cash or other non-qualifying property (called "boot"), you pay tax on the gain up to that amount.
- You report it. The exchange is reported to the IRS on Form 8824 with your tax return.
The two deadlines that matter most
The clock starts the day your sale closes, and both dates are strict. According to the IRS:- Day 45: identify your replacement property. You must name the property or properties you may buy in writing within 45 days of transferring the property you gave up.
- Day 180: close on the replacement property. You must receive it within 180 days of the transfer, or by the due date of your tax return (including extensions) if that comes first.
How I help, step by step
Before you sell- Talk to your CPA and a qualified intermediary first. They confirm that an exchange makes sense and set up the paperwork before your sale closes. I can introduce you to professionals if you need them.
- Decide what you want to buy. We talk about your goals: monthly income, appreciation, a smaller or larger property, a different city or less hands-on management.
- Study the local market. Over the past 12 months, the median sold price for houses was about $1.41 million in Newark, $1.715 million in Fremont and $1.40 million in Union City. For condos and townhomes it was $820,000, $835,000 and $650,000. I show you what your sale price can buy in each city.
- Search before the clock starts. I set up searches for your target properties before your sale closes, so you can tour as soon as you have a firm closing date.
- Run the numbers together. For each property we look at price, recent comparable sales, likely rents, property taxes, HOA dues and the repairs it may need.
- Build a backup list. Because your written list is due on day 45, we identify more than one property you would be happy to own.
- Write an offer that fits the schedule. The contract needs to work with your exchange deadlines, and I make sure the closing date leaves room before day 180.
- Coordinate the team. I keep your intermediary, escrow, title company and lender on the same page so the funds move correctly.
Mistakes that can sink an exchange
- Waiting to hire an intermediary. The intermediary must be in place before your sale closes. If sale proceeds land in your own account, the exchange may fail.
- Missing a deadline. If you miss day 45 or day 180, the exchange does not qualify and the gain can be taxable in the year of the sale.
- Taking cash out. Any cash or non-qualifying property you receive is "boot," and you pay tax on the gain up to that amount. To defer all of the tax, you generally need to buy replacement property of equal or greater value and reinvest all of the net proceeds. Your CPA can confirm what applies to you.
- Overlooking the related-party rules. Relatives and your own agents cannot serve as your intermediary. If you or a related party disposes of the property received in the exchange within 2 years, the deferred gain generally has to be reported.
- Starting with the wrong property. A home you lived in as your only residence, or a property you bought to resell quickly, generally does not qualify.
- Rushing the purchase. A tight clock tempts people to skip inspections or to buy a property that does not fit their goals. Looking early protects you.
- Forgetting California's reporting rule. If you exchange California property for property outside California, the California Franchise Tax Board requires you to file Form FTB 3840 with your return for the year of the exchange and every year after until the deferred California gain is recognized. If you do not, the state may issue an assessment with penalties and interest.