Also known as a like-kind exchange, a 1031 swap or exchange is named after the tax code of the same number. Essentially, it allows for the swap of one business or investment asset for another, with either no or limited tax due at the time of the exchange.
There are no limits to the number of times or dollar amounts you can move around with these investments. So theoretically, you could buy a property for $100K, see it appreciate $20K, and instead of selling it and paying capital gains tax, roll the entire amount into a new property. Let’s say you buy a new, $120K property. It appreciates to $150K, you roll it over. And on and on.
By using 1031 swaps, you would avoid paying taxes indefinitely. Say you finally want to retire one day—you would then cash out and owe a one-time, long-term payment based on the capital gain rate (currently 15%).
So, what qualifies for a 1031 swap? It is generally real estate, and “like-minded” cuts a wide swath in IRS terms. For example, you could swap out a cattle ranch for a strip mall. A gas station for an apartment complex, etc. They have to be investments, not personal property. There are exceptions to this, but we will avoid them for the purposes of this article.
There are a couple other rules that apply to 1031s. Since the sale of one property rarely syncs up with the purchase of a new one, the provision allows for a “delayed exchange,” giving you extra time. However, there are limits. A replacement property must be designated within 45 days of the closing of sold property. You must also close on your replacement property 180 days after the sale date.
Important to note that any cash you touch in the process will effectively kill the swap, with all its tax benefits in tow. This has opened up an opportunity for banks to fill the custodial role of intermediary. You can read more about that HERE.