The simple answer is yes. For owners who want to sell their current investment property while purchasing another, a 1031 exchange might be a good option. A 1031 exchange is a tax-deferred exchange that allows property owners to postpone capital gains taxes by reinvesting sale proceeds into another qualifying property. However, strict rules must be followed for the exchange to remain tax-deferred.
Knowledgeable real estate investors often utilize this exchange mechanism due to its tax advantages. Here, we will discuss the qualifications for a 1031 exchange and explain how it works.
WHAT IS A 1031 EXCHANGE?
The term “1031 exchange” is taken from the Internal Revenue Service (IRS) code Section 1031, which discusses swapping one investment property for another without immediately incurring capital gains taxes. [1] Investors should remember that this is not a tax-free strategy but a tax-deferred one. Taxes on previously deferred gains will eventually be due when the investor sells without reinvesting in another qualifying property. 1031 exchanges can help investors defer taxes, grow their portfolios, and diversify their investments, while also offering estate planning advantages. However, 1031 exchanges have strict requirements, including timing restrictions, property eligibility, and reinvestment value thresholds.
TIMING CONSIDERATIONS: IDENTIFICATION & REPLACEMENT PERIODS
1031s have strict timing requirements that must be followed to maintain tax-deferral status. When the current property sells, the proceeds must be held by a Qualified Intermediary (QI), a third-party facilitator whose services are required to remain IRS-compliant. The seller cannot directly receive sale proceeds; if this happens, the sale proceeds become taxable.
An investor has 45 days from closing the sale to identify replacement properties. Most investors use the “Three-Property Rule,” which allows them to identify up to three like-kind properties. Still, other IRS rules permit more flexibility on the number of replacement properties, although not without additional regulations. This 45-day window is known as the identification period. The taxpayer has this allotted period to identify properties that can replace the relinquished property. [1]
The buyer must purchase one or more of the three replacement properties within 180 days once the properties have been identified. The title and taxpayer name must match the sold property. One exception to this rule may apply if you are the sole member of an LLC or an LLC member passes down the property to you. If an investor conducts multiple 1031 exchanges, each property has its own 180-day purchase window, starting from its sale date. This allows investors to strategically stagger transactions.
These timing rules are in place because of a case known as the Starker case, wherein the taxpayer could sell relinquished property on one day and acquire a replacement at a different time, five years later, to be exact. This rule no longer makes it necessary for an exchange to be simultaneous while giving investors time to look for a replacement. [2][3]
Because of time constraints, you do not want to sit on the market’s sidelines, so there is pressure to make quick decisions, which runs the risk of overpaying or compromising on quality in some other way. A 1031 exchange has plenty of moving parts that investors must understand before attempting. Ensuring that the exchange follows specific qualifications will help keep it tax-deferred.
Work with a qualified intermediary to understand the intricate details of a 1031 exchange. Their job is to keep investors from making mistakes that could affect their tax-advantaged sales.
WHAT IS A “BOOT” IN A 1031 EXCHANGE?
Investors interested in 1031s need to know about boot. A “boot” is the taxable portion of an exchange. The exchange will not be completely tax-free if an investor generates boot. Boot can be generated by taking out cash from the proceeds of a sale, spending less than the exchange value on the replacement property, not replacing debt paid off on the relinquished property, over-mortgaging the replacement property, or paying debts not secured by a mortgage or deed of trust on the relinquished property. [4]
For example, if a replacement property is worth less than the sold property, you will owe taxes on the difference. So, to avoid boot, you must reinvest 100% of the proceeds and replace it with equal or greater debt.
HOW DO YOU QUALIFY FOR A 1031 EXCHANGE?
The properties need to be considered “like-kind” in the eyes of the IRS to qualify for a 1031 exchange and have the capital gains taxes deferred. This only applies to commercial and investment properties because personal properties do not qualify for a 1031 exchange. So, while your primary residence will not be accepted for a 1031 exchange, your rental property may be exchanged for a similar rental property. [4]
A “like-kind property” is a broad term, meaning most real estate properties are like-kind. An apartment building would generally be considered like-kind to another apartment building. Even if the properties differ in quality or grade, they can be regarded as like-kind if they are of similar nature or character. That said, real estate properties in the U.S. are not like-kind to properties outside the country. [4]
To qualify for a 1031 exchange, however, the property replacing the original one must be of equal or greater value. This means the equity and the market value of the investment property you purchase must be equal to or greater than what you sold the current property for. [4]
No limit exists on how frequently an investor can conduct 1031 exchanges, provided they do it properly.
WHAT QUALIFIES AS AN INVESTMENT PROPERTY?
For a 1031 exchange, real estate properties that qualify in a 1031 exchange must be held for use in a trade or business for investment. “Held for investment” means that if the property is improved, it is intended to generate income or appreciate over time. This means that a taxpayer who, for example, allows their children to live in the property rent-free or a taxpayer who holds the property but does not rent it is not holding it for investment and would not qualify for a 1031 exchange. [2]
CAN I 1031 EXCHANGE INTO ONE OF BAM CAPITAL’S FUNDS?
BAM Capital’s funds are not structured to accept direct 1031 exchange proceeds; however, investors may still achieve tax benefits through alternative strategies such as depreciation, passive loss activity rules, or tax-advantaged investment vehicles.
WORK WITH BAM CAPITAL
When picking a multifamily project to invest in, there are a few factors you need to consider. Regardless of your strategy for finding these deals, you will indeed have a lot of options. It’s all about picking the right one for you.
BAM Capital partners with accredited investors looking for high-value syndication opportunities that can generate more income. As the private equity arm of The BAM Companies, BAM Capital has been focusing on buying assets targeted as having strong profitability potential and staying disciplined in its investment thesis. BAM Capital’s investment strategy aims to create forced appreciation while mitigating investor risk. To date, the brand has successfully managed over $1.7 billion in assets across ~9,000 apartment units.
Remember that no investment is without risk. Before making financial decisions, consult your investment advisor and schedule a call with a BAM Capital investment team member.
For additional multifamily real estate insights, visit Pathways to Passive Wealth, BAM Capital’s new platform designed to make real estate investing more accessible, transparent, and achievable for aspiring and experienced investors.
Disclaimer: All investments carry risk, including potential loss of capital. This content is for informational purposes only and is not financial, legal, or investment advice, nor an offer or solicitation to buy or sell any security. Consult an independent advisor for personalized guidance and contact BAM Capital for details on current offerings. BAM Capital and its representatives are not fiduciaries or investment advisors. The information provided is general and may not reflect individual financial goals. Any financial terms, projections, or forward-looking statements contained herein are hypothetical in nature and should not be interpreted as guarantees of future performance or safety. Such statements reflect BAM Capital’s opinion and are subject to market fluctuations, economic conditions, and investment risks. Past performance does not predict future results. BAM Capital and its affiliates do not guarantee the accuracy or completeness of this information. BAM Capital offers investment opportunities under Rule 506(c) of Regulation D exclusively for accredited investors as defined by the SEC. Verification of accredited investor status is required prior to participating in any investment.
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SOURCES:
[1]: BAM Capital. (2021). “How Do You Qualify for a 1031 Exchange?” https://bamcapital.com/1031-exchange/
[2]: Morris Invest. (n.d.). “What’s the Difference Between A, B, C & D Class Neighborhoods?” https://morrisinvest.com/blog/2016/12/2/whats-the-difference-between-and-a-b-and-c-neighborhood/
[3]: LeaderBank. (2024). “What is a Section 1031 Exchange or Starker Exchange?” https://www.leaderbank.com/blog/what-section-1031-exchange-or-starker-exchange
[4]: BAM Capital. (n.d.). “Current Portfolio.” https://capital.thebamcompanies.com/
