How to Prepare for Your 1031 Exchange

1031 exchange transactions have grown in popularity in recent years—especially with buyers looking to take advantage of top pricing and avoid capital gains taxes. While these exchanges are popular, they can also be difficult in this market considering the competition for quality assets and the limited supply of for-sale properties. Timing—the key to a 1031 exchange—becomes a crucial obstacle and buyers need to prepare before entering the process.

“1031 exchanges are a notoriously difficult transaction to do well, and the biggest reason is timing and complexity,” Davin Carey, managing financial advisor at Carey & Hanna, tells GlobeSt.com. “Timing is the big one, and people underestimate how significant that timing pressure it. For a 1031 exchange to be successful, there are a few things that need to happen, otherwise it is not fully tax deferred, or in some cases if you do it wrong, none of the taxes are deferred and they are due immediately.”

The first step begins during the for-sale process on the upleg of the transaction, and this is a step that buyer’s often miss, essentially excluding them from the exchange option. “Even before the property sells, it is really important that the seller notifies the buyer in escrow that they intend to do a 1031 exchange because they proceeds on the date of the closing can never go to the seller,” explains Carey. “The seller can never have constructive receipt of the proceeds. Even before the transaction closes, the seller has to notify escrow that they are going to potentially be doing a 1031 exchange and that they are going to have a qualified intermediary that the proceeds will go to. That actually changes the way that the paperwork is structured. That is a big step. You have to do this before the property closes.”