What Happens When You Sell a 1031 Exchange Property

Selling a 1031 exchange property can feel overwhelming if you don’t know what to expect. Understanding what happens when you sell a 1031 exchange property is essential. Whether you’ve deferred taxes on your first exchange or you’re managing multiple properties, understanding the process is crucial. Let’s break it down step-by-step to help you make the right moves and avoid costly mistakes.

The Basics of Selling a 1031 Exchange Property

When you sell a property acquired through a 1031 exchange, the tax-deferred gains don’t disappear. Instead, they carry over to the new property. This is why planning your next steps is so important.

Key Terms to Know

  • Deferred Gain: The capital gain from your original property sale that you postponed through the 1031 exchange.
  • Boot: Any cash or non-like-kind property you receive, which can trigger taxes.

Holding Period Requirements

The IRS expects you to hold onto your replacement property for investment or business purposes. Generally, a holding period of two years is safe, but it’s not a hard rule. Consult with a tax advisor to ensure you meet IRS expectations.

Tax Implications When Selling

Selling a 1031 exchange property comes with tax responsibilities. Here’s what you need to know.

Recognizing Deferred Gains

The gains you deferred through the original exchange don’t vanish. When you sell the property, those gains become taxable unless you roll them into another exchange.

Let’s say you sold a property for $500,000 and deferred $100,000 in gains through a 1031 exchange. When you sell the replacement property, that $100,000 deferred gain becomes part of your tax calculation.

Calculating Capital Gains Taxes

When you sell, you’ll owe taxes on:

  • The original deferred gain.
  • Any additional gain from the sale of the replacement property.

For example, if the property has appreciated further, you’ll pay taxes on both the deferred gain and the new gain unless you reinvest. Check out our capital gains tax calculator.

Watch Out for “Boot”

If you receive cash or non-like-kind property in the transaction, it’s considered boot. Boot is taxable, even if you complete another 1031 exchange.

Options After Selling a 1031 Exchange Property

What you do after selling your 1031 property matters. You have two main options: defer taxes again or pay up.

Rolling Into Another 1031 Exchange

You can defer taxes again by initiating another exchange. The process works the same as before:

  1. Identify a new property within 45 days.
  2. Close on the new property within 180 days.

Each exchange allows you to postpone taxes, creating a powerful tool for building wealth.

Paying Taxes on the Sale

If you decide not to reinvest, you’ll owe taxes on the deferred gain and any new gains. This includes:

  • Federal capital gains taxes.
  • State taxes (if applicable).
  • Depreciation recapture taxes.

Working with a CPA can help you minimize your tax liability.

Special Situations to Consider

Estate Planning and Step-Up in Basis

If you hold onto your 1031 property until your death, your heirs benefit from a step-up in basis. This eliminates deferred gains and reduces their tax burden. It’s an effective estate planning strategy.

Depreciation Recapture

When you sell, you must account for depreciation recapture. This is a tax on the depreciation you claimed during ownership. It’s taxed at a higher rate, so plan accordingly.

Practical Tips for Selling

Selling a 1031 exchange property isn’t just about timing. Preparation is key.

Engage a Professional Early

Start with a qualified intermediary (QI). They’ll guide you through the process and ensure compliance with IRS rules.

Keep Your Documentation

Maintain records of the original exchange. This includes contracts, settlement statements, and QI agreements. Proper documentation ensures a smoother sale and tax calculation.

Plan for Depreciation Recapture

Work with a tax advisor to estimate your tax bill. Knowing your depreciation recapture liability helps you plan financially.

Common Pitfalls to Avoid

Selling Too Soon

If you sell before meeting the holding period requirement, the IRS may disqualify your exchange. This could result in immediate taxes on the deferred gain.

Missing Exchange Deadlines

If you plan to reinvest, don’t miss the 45-day identification or 180-day closing deadlines. Late actions disqualify your exchange. Check out our 1031 exchange deadline calculator.

Underestimating Depreciation Recapture

Depreciation recapture can surprise sellers with higher tax bills. Work with a professional to avoid this.

Conclusion

Selling a 1031 exchange property doesn’t have to be complicated. By understanding the process and working with professionals, you can make informed decisions and maximize your investment. Whether you choose to defer taxes again or pay them, preparation is the key to success. Ready to sell? Start planning today and keep building your real estate portfolio.

Get Started Today

It is easy to get started on your exchange. You can either call our office directly at 888-508-1901, or you can fill out our Start Your Exchange form.
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