1031 Exchanges and Financing: What to Know
Section 1031 of the tax code allows real estate investors to defer capital gains when one investment property is exchanged for another. Financing the replacement property has specific rules and timelines that lenders need to coordinate with.
The 45-Day and 180-Day Rules
From the date of sale of the relinquished property, the investor has 45 days to identify potential replacement properties and 180 days to close on one. These are hard deadlines — missing them disqualifies the exchange and triggers the gain.
Like-Kind and Equal-or-Greater
Replacement property must be 'like-kind' (generally, real estate for real estate within the U.S.) and must be of equal or greater value than the relinquished property to fully defer the gain. Buying down in value generates a partial taxable event ('boot').
Financing the Replacement
The replacement property typically needs to carry at least as much debt as the relinquished property to avoid taxable boot. If the relinquished property had $1M of debt and the replacement has $700K, there is $300K of 'mortgage boot' that may be taxable.
Working with the Qualified Intermediary
1031 exchanges require a qualified intermediary (QI) to hold the proceeds from the relinquished property sale. The QI also coordinates the wiring of funds to acquire the replacement. Lenders need to understand the QI structure and time their funding accordingly.
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