1031 Exchange Rules for Texas Investors
A Section 1031 exchange lets an investor defer federal capital gains tax by exchanging real property held for investment or business use for other like-kind real property. The investor must use a qualified intermediary, identify replacement property within 45 days after selling and close within 180 days. Cash or debt relief not replaced is called boot and is taxable. Texas has no state income tax, so the deferral concerns federal tax.
The basics
- The exchange applies to real property held for investment or business, not a primary residence or property held mainly for resale.
- Since 2018, the rule applies only to real property, not equipment or other personal property.
- Like kind for real property is broad: raw land can be exchanged for an apartment building, for example.
- The exchange defers tax. It does not forgive it, and basis carries over to the new property.
The deadlines
| Deadline | Rule |
|---|---|
| 45 days | Identify replacement property in writing to the qualified intermediary after the sale of the relinquished property |
| 180 days | Close on the replacement property, or the tax return due date if earlier, counted from the sale |
The deadlines run at the same time and are strict. They are not extended for weekends or holidays.
Identification rules
- Three property rule. Identify up to three properties of any value.
- 200 percent rule. Identify any number of properties if their total value does not exceed 200 percent of the value of the property sold.
- 95 percent rule. Identify more if you acquire at least 95 percent of the value identified.
Qualified intermediary and constructive receipt
The investor cannot receive the sale proceeds. A qualified intermediary holds the money and acquires the replacement property for the investor. Touching the funds, even briefly, can disqualify the exchange. The intermediary should be engaged before closing the sale, and the exchange agreement should be in place before the closing date.
Boot, related parties and other issues
- Boot. Cash left over, or debt reduced without being replaced, is taxable. To defer all gain, buy equal or greater value and replace the debt.
- Related parties. Exchanges with related parties have holding period limits.
- Reverse exchanges. The replacement is bought before the sale through a parking arrangement, with more complexity.
- Delaware statutory trusts. Some investors use fractional interests in a DST as replacement property.
- Entities. The same taxpayer must be on both sides, so plan entity structure early. See holding real estate in an LLC.
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Book Free ConsultationFrequently asked questions
Can I do a 1031 exchange on my home?
Not on a primary residence. It applies to investment or business property.
Does Texas tax the gain I defer?
Texas has no state income tax. If property in another state is involved, that state's rules may apply.
What if I miss the 45-day deadline?
The exchange generally fails, and the gain is taxable in the year of sale.
Do I need a qualified intermediary?
Yes. A properly structured exchange needs one to hold the proceeds.