Bartos Group BLOG

In the Really Mary?! episode “1031 Exchanges: Expert Insights with Craig Couture, CPA,” Mary Bartos sits down with Craig Couture to unpack how 1031 Exchanges can be used to defer capital gains tax when selling and reinvesting in real estate. This article summarizes their conversation, expands on the practical and accounting details they highlighted, and provides clear guidance and frequently asked questions for investors considering a 1031 Exchange.

What are 1031 Exchanges and Why They Matter

1031 Exchanges enable owners of investment real estate to sell one property and acquire another like-kind property while deferring capital gains tax on the sale. As Craig explained, the strategy “works really well for individuals that have a lot of capital gains that they don’t want to pay tax on—they want to defer it and push it down the road.” In plain terms, a properly executed 1031 Exchange allows investors to trade up, diversify, or consolidate holdings without immediately triggering the tax bill that would otherwise accompany a taxable sale.

Basic Mechanics: How a 1031 Exchange Works

At its core, a 1031 Exchange replaces a taxable sale-and-buy transaction with an exchange structure. A few essential elements were emphasized during the conversation:

• Like-kind property: The replacement must be real property held for business or investment. The rule is broad for real estate—most real property will be considered like-kind to other real property.
• Qualified intermediary: Before closing the sale of the relinquished property, an investor must hire a qualified intermediary (QI). Craig stressed that the intermediary “will collect the money at closing and hold on to it,” and that if the seller takes possession of the cash, the transaction fails to qualify as a 1031 Exchange. As he put it plainly, “once it goes into your hands, it’s not a like-kind Exchange.”
• Timing rules: The tax code imposes strict timing: an identification period and a completion period. While Craig focused on the six-month acquisition window, the full rules require identification of replacement property within 45 days and acquisition of the replacement property within 180 days (six months) of the relinquished property’s sale.
• Replacement value and equity: To fully defer gain, the investor generally must acquire replacement property(ies) equal to or greater in value and reinvest all net proceeds. Any cash left behind or debt relief taken may trigger taxable boot.

Key Administrative and Accounting Considerations

Craig emphasized several accounting and documentation points that investors and advisors must track carefully when executing 1031 Exchanges.

• Engage the intermediary early: Hiring the QI prior to the sale is not optional. If proceeds are routed to the seller directly, the opportunity to treat the transaction as a 1031 Exchange is lost.
• Track deferred gain and cost basis: When an investor defers gain through a 1031 Exchange, the taxable gain doesn’t disappear—it is carried forward. Craig noted that the deferred amount affects the carryover basis of the replacement property. The transaction is reported to the IRS and the carryover basis is tracked on a tax form that will follow the property until a taxable disposition occurs.
• Proper tax reporting: Form 8824 (like-kind exchanges) is used to report the exchange to the IRS. This form documents details such as the realized gain on the relinquished property, the amount of gain deferred, and the basis of the replacement property. Craig described it as “a form that carries forward” until the investor eventually disposes of the property in a taxable transaction.
• Contracts and documentation: Contracts should be coordinated so that purchase agreements, identification notices, and closing instructions align with exchange timelines. Craig mentioned that accounting things to monitor include “contracts” as well as “how much money do I have that would have been taxed that was deferred.”

Common Pitfalls and Practical Advice

Based on the conversation, a few pitfalls repeatedly trip up investors—and each is avoidable with planning and professional help.

• Missing the intermediary step: Several of Craig’s clients mistakenly received sale proceeds because they did not realize an intermediary was required. That error converts what could have been a tax-deferred exchange into a taxable sale.
• Failing to meet timing rules: The 45-day identification and 180-day exchange windows are firm. Missing them typically results in disqualification of the exchange.
• Using property for personal use: If an investor converts a property to personal use (for example, living in it part of the time), the exchange eligibility becomes a case-by-case determination. Craig advised consulting a tax professional well before closing in such situations.
• Taking boot: If the replacement acquisition is smaller in value, or if the investor receives cash or relief from debt, that portion may be taxable and is referred to as “boot.”

When a 1031 Exchange May Not Be Appropriate

While 1031 Exchanges offer definite tax advantages, they are not universally the best choice. Consider these scenarios:

• Need for liquidity or cash: If an investor wants cash now to finance retirement or other projects, deferring tax may not align with personal goals.
• Short-term ownership or conversion to personal use: Properties intended to be converted to personal residences or held for a short period may fail to meet the investment-use requirement.
• Complex estate planning goals: In some cases, investors may prefer a taxable sale now if it aligns with estate planning strategies (for example, to obtain a step-up in basis for heirs).

How Cost Basis Carries Forward

A crucial accounting point Craig raised is how basis is treated in a 1031 Exchange. When gain is deferred, the basis of the relinquished property typically carries over to the replacement property, adjusted for any additional cash invested or boot received. That carryover basis remains until the taxpayer ultimately sells the replacement property in a taxable transaction, at which time the previously deferred gain is recognized.

Form 8824 will show the details of the exchange and the basis adjustments. Tax records should clearly document the deferred gain and the adjusted basis to ensure accurate reporting in the future.

Practical Checklist Before Attempting a 1031 Exchange

To reduce risk and maximize the chance of a successful exchange, Craig recommends the following practical steps:

1. Consult a tax professional and real estate advisor early in the process.
2. Engage a qualified intermediary before listing or closing the relinquished property.
3. Plan replacement property options and ensure identified properties meet like-kind rules.
4. Confirm the 45-day identification and 180-day acquisition deadlines and create a timeline to meet them.
5. Coordinate contracts and closings so that funds never pass through the seller’s hands.
6. Document basis adjustments, deferred gain amounts, and file the appropriate tax forms (e.g., Form 8824).

FAQ: Common Questions About 1031 Exchanges

Can anyone use a 1031 Exchange?

1031 Exchanges are available to taxpayers selling property held for business or investment. They are not available for properties held primarily for personal use, such as a primary residence.

What is a qualified intermediary and why is one required?

A qualified intermediary (QI) is a neutral third party who holds the sale proceeds and facilitates the exchange. The QI prevents the seller from having constructive receipt of funds. As Craig warned, if proceeds are distributed to the seller, “it’s not a like-kind Exchange.”

How long do investors have to complete an exchange?

Two deadlines apply: the investor must identify potential replacement property(ies) within 45 calendar days of the sale of the relinquished property, and the exchange must be completed within 180 calendar days (six months) from the sale.

Can an investor buy multiple replacement properties?

Yes. Investors may identify and acquire multiple replacement properties. The three-property rule and the 200% rule are identification safe harbors that govern how many properties may be identified, but proper planning with counsel is essential.

What happens to the deferred gain?

The deferred gain carries forward into the basis of the replacement property. When the investor eventually sells without a qualifying exchange, the previously deferred gain becomes taxable unless another qualifying transaction defers it further.

Is there a situation where 1031 Exchanges aren’t advisable?

Yes. If the investor requires liquidity, seeks to simplify holdings for personal reasons, or is considering estate planning strategies where a taxable sale now could be beneficial, a 1031 Exchange may not be the best option.

Conclusion

1031 Exchanges are a powerful tool for preserving wealth within real estate investments by deferring capital gains tax. As Craig Couture emphasized during the discussion with Mary Bartos, the strategy “just keeps kicking that down,” allowing investors to grow and reposition portfolios without the immediate tax drag of a taxable sale. The trade-off is strict rules and careful documentation: hire a qualified intermediary before closing, follow the 45-day and 180-day timelines, track deferred gain and basis adjustments on the proper tax forms, and consult trusted tax and real estate professionals before committing.

For investors in Southwest Florida and beyond, thoughtful use of 1031 Exchanges can be a central part of long-term real estate strategy. When in doubt, reach out to a CPA or qualified exchange professional to make sure your transaction is structured correctly and your tax outcomes align with your goals.