Property Management Blog

A Guide to 1031 Exchanges in Dallas

System - Monday, May 2, 2022
Property Management Blog

Usually, the Internal Revenue Service will levy a tax on the sale of a property or other investment. This tax could run as high as 30% when you combine both federal and state taxes. 

Luckily, there is a way around this tax for Dallas investors! 

While you’ll eventually have to pay capital gains taxes, you may be able to defer the payments almost indefinitely, and potentially avoid paying the tax altogether! This method of deferring capital gains tax is what is referred to as a 1031 Exchange. 

The term ‘1031 Exchange’ takes its name from Section 1031 of the Internal Revenue Service Code. Many savvy real estate investors have capitalized on this method to significantly grow their real estate investments. 

The following is a guide to help you do a 1031 Exchange in Dallas, TX.

What Properties Qualify for a 1031 Exchange?

Not all properties are qualified under Section 1031 of the Internal Revenue Service Code. The code requires that a property be used for business or for investment purposes in order to qualify.

Also, in addition to being used either for business or investment purposes, the IRS requires that properties be like-kind. Properties that are like-kind are those that share the same nature or character, even if they may not share the same grade or quality. 

1031 exchange rules dallas tx]

Below are examples of real estate swaps that would fit the requirement of “like-kind”.

  • An office in exchange for a single-family home
  • Raw land in exchange for an apartment
  • Raw land in exchange for an office building
  • A shopping center in exchange for an industrial building

As already mentioned, not all kinds of properties qualify for a 1031 Exchange. A personal residence, for instance, wouldn’t qualify as it isn’t used for business or for investment purposes. Neither would a fix-and-flip property, as it’s solely purchased for resale.

Other kinds of investments that don’t qualify include:

  • Inventory and certificates of trust
  • Partnership interests
  • Debt instruments
  • Stocks
  • Bonds

If you exchange these type of assets, the exchange would not only fail but you’d also be liable for capital gains taxes.

What are the Purchase Deadlines Under IRS Section 1031?

There are deadlines that you must abide by when it comes to swapping properties. There is the 45-day and the 180-day rule. These periods are strict and cannot be extended.

45-Day Rule

The first timing restriction imposed by the IRS is the 45-day rule. According to this rule, you have 45 days from the date of sale of the relinquished property to identify its potential replacement. 

45 day rule irs tx

You have two options when it comes to the number of properties you can identify. In the first option, you can identify a maximum of three properties. It doesn’t matter how much they’re worth. 

Suppose, for instance, that you sell a condominium for $100,000. Under the IRS Code, you could list three $3 million dollar offices for exchange. Obviously, closing on them might be challenging if what you’re selling is a $100,000 property, but on paper, it’d check out.

The second option you have is to identify a minimum of three properties. If you go with this option, then the total value must not exceed twice the value of the relinquished property. 

Let’s use the previous example of a $100,000 condo. The total value of the replacement properties must not exceed $200,000. So, if you sell the $100,000 condo, then you’d be able to purchase five replacement properties each worth $40,000.

180-Day Rule

The other deadline to abide by when conducting a 1031 Exchange is the 180-Day rule. This rule states that an investor must complete the entire real estate transaction within 180 days. The period runs concurrently with the 45-day identification rule. 

avoid capital gains taxes texas

The 180-day period starts from the moment you sell the property you’re relinquishing. This, therefore, means that you have 135 days (180-45) to close on the replacement property. It goes without saying that the property you close on must be one from your 45-day list.

Who is a Qualified Intermediary and What is Their Role?

A Qualified Intermediary (QI) is a third party who coordinates a 1031 Exchange. They will help you sell a relinquished property and buy the replacement property on your behalf. As a matter of fact, the IRS Code requires that an investor doesn’t keep any funds involved in the 1031 Exchange transaction. 

A qualified intermediary can be an investment broker, a real estate agent, an attorney, or a CPA.

What is a “Boot” in a 1031 Exchange?

Boot refers to non-like-kind property received in a 1031 exchange. In other words, it’s any additional value that’s received when a replacement property is acquired. The following are some tips on how to avoid a boot in a 1031 Exchange.

  • Increase or maintain the debt amount on the replacement property.
  • Make sure you reinvest all the proceeds from the relinquished property into the replacement property through actions such as conducting maintenance or renovations.
  • Trade up in value. Ensure the value of the replacement property exceeds the value of the property you’re relinquishing.
  • Either include personal property such as furniture and appliances in the purchase price or handle them in separate transactions.

1031 exchange boot

  • Bring cash with you on closing day to pay for items that aren’t like-kind. These items include things like tenant deposits, rent prorations, and outstanding vendor invoices.

What are the Different Types of 1031 Exchanges?

The following are the four types of 1031 Exchanges according to Section 1031 of the Internal Revenue Service Code.

  • Simultaneous Exchange
  • Improvement Exchange
  • Delayed Exchange
  • Reverse Exchange

Bottom Line

The IRS has very strict procedures on how a 1031 Exchange must be conducted. That’s why hiring an expert is always recommended, especially if this is your first attempt at a 1031 Exchange!

SGI Property Management can help!

We not only understand the 1031 Exchange process in Dallas, but we’re also a full-service property management company with over 100 rental properties in our portfolio. Get in touch with us to learn how we can help you grow your investment portfolio!