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1031 Exchange Process: A Step-By-Step Guide

August 15, 2023

The 1031 exchange involves a simple process that savvy real estate investors must follow diligently to complete a successful exchange.

Understanding the 1031 exchange process will not only make your life easier, but also ensure compliance with the IRS requirements and deadlines.

Here at Universal Pacific 1031 Exchange, our team has over 30 years of experience in the analysis, acquisition, management, brokerage and disposition of over $350 million worth of real estate, including overseeing 1031 tax deferred exchanges where applicable & tax reporting requirements.

This article will provide a simple and complete step-by-step guide to the 1031 exchange process.

The 1031 Exchange Process

Evaluate The 1031 Exchange Opportunity

Evaluate The 1031 Exchange Opportunity

Although 1031 Exchanges offer significant tax benefits, they’re not for everyone. Before deciding, you’ll want to consider your property ownership structure. Is it held personally, in an LLC, trust, or other entity? This affects the exchange process.

From there you can evaluate your potential capital gains tax liability against the tax deferral benefits of a 1031 Exchange, and assess your liquidity needs, as this process ties up your capital for a significant period. The strict rules around acquiring a property of equal or greater value and potentially taking on equal or greater debt require close attention.

Choosing a Qualified Intermediary (QI)

Choosing a Qualified Intermediary (QI)

From preparing the legal agreements and documentation of properties to ensuring IRS compliance, a Qualified Intermediary plays a pivotal role in a successful 1031 exchange. The QI holds the proceeds from the sale in a secure escrow account while the investor identifies a like-kind replacement property. When the deal is ready, the QI releases the funds for the purchase of the replacement property.

Different kinds of 1031 exchanges may require different processes and requirements. So, you need to be sure that a QI can successfully facilitate a 1031 exchange before you engage them. Consider important factors such as expertise and experience level, costs and fees, and customer service before choosing a QI.

To make this substantial financial decision with clarity, schedule a consultation with a Qualified Intermediary, such as Universal Pacific 1031 Exchange. This can be done via phone or in person at our office. We can provide tailored advice based on your specific circumstances, guide you through the strict legal and regulatory requirements, and help you assess whether a 1031 Exchange aligns with your broader financial and life goals.

Selling the Relinquished Property

The funds from this sale flow through the QI to keep your tax benefits intact. You’ll want to ensure the sale’s timeline aligns with the forthcoming stages.

Identifying Potential Replacement Properties (45 Days)

Selling the Relinquished Property

After selling the relinquished property, you have 45 days to identify potential replacement properties. This phase demands focused research, market understanding, and a clear investment strategy.

Before closing a deal, you need to ensure that the replacement properties meet the requirements stipulated by the IRS for 1031 exchange eligibility. Here are some notable criteria to keep in mind.

Like-kind Properties

Replacement properties for a 1031 exchange must be like-kind. According to the IRS, like-kind properties are properties that are similar in nature, character or class without regard to grade or quality. For instance, a residential building can be like-kind to a vacant land, but cannot be exchanged for an artwork.

The 200% Rule

This rule allows you to identify multiple replacement properties provided that their cumulative value is not more than 200% of the value of the relinquished property.

The Three Property Rule

This rules lets you identify up to three replacement properties of any value. If you identify more than three, then the 200% rule applies.

The 95% Rule

The 95% rule provides that you can identify more than three properties worth more than 200% of the relinquished property but on the condition that you must acquire at least 95% of the value of the identified properties.

  • The replacement properties must be of equal or greater value compared to the relinquished property.
  • The replacement properties must be held for investment purposes and not for direct sales or personal use.

Acquiring the Replacement Property (180 Days)

Acquiring the Replacement Property

You have 180 days from the sale of the relinquished investment property to acquire one or more of the identified replacement properties. The QI releases the funds from the escrow account to complete the purchase. Again, the replacement property must be of equal or greater value than the relinquished property to defer capital gains tax.

Potential Consequences of Missing Deadlines

If you’re not able to identify replacement properties within the 45-day window or acquire a replacement property within the 180-day completion period, the exchange will be disqualified.

As a result, you will incur the tax liabilities on the capital gains from the sale of the relinquished property.

The Role A QI in the 1031 Exchange Process

The IRS requires the use of a Qualified Intermediary (QI), also known as an Accommodator or Facilitator, to ensure that the exchange process is timely and seamless.

The primary responsibilities of a QI include:

Safekeeping of Funds

The QI holds the proceeds from the sale of the relinquished property in a secure escrow account, preventing the taxpayer from directly accessing the funds. This helps ensure that the taxpayer does not violate the terms of the deal, thereby maintaining the integrity of the exchange to ensure it qualifies for tax deferral.

Facilitating the Exchange

The QI handles various aspects of the exchange. During the identification period, the QI assists the investor in formally identifying potential replacement properties within the designated timeline. They also assist in preparing the necessary exchange documents, terms and conditions of the transactions, and coordinating with the closing agents. Once a replacement property is selected, the QI coordinates with the relevant parties to acquire the investment property within the exchange timeline.

Compliance with IRS Regulations

The QI ensures that all the exchange steps adhere to IRS regulations and guidelines. This includes verifying that the properties qualify as like-kind, adhering to the 45-day identification and 180-day exchange timelines, and ensuring proper documentation.

Guidance and Consultation

Throughout the process, the QI serves as a knowledgeable resource for the investor. They offer guidance, answer arising questions, and address concerns related to the exchange process.

Types of 1031 Exchanges

Types of 1031 Exchanges

The 1031 exchange process offers various options to suit different investment scenarios and objectives. Each type of exchange comes with its unique requirements and benefits. Here are the common types of 1031 exchanges.

Simultaneous Exchange

A simultaneous exchange allows you to relinquish an investment property and acquire a replacement property at the same time. Any delay in the transaction may disqualify your exchange for a tax deferral.

Simultaneous exchanges can either be a two-party or three-party exchange. A two-party exchange involves a direct property swap between you and another party. A three-party exchange involves an indirect swap with a second party. While the second party may not possess the real property at the time of the exchange, they can get the replacement property from a third party and transfer to you.

Delayed Exchange

The delayed exchange, also called a “deferred exchange,” is the most common type of 1031 exchange due to its time advantage. Here, there is a time gap between selling the relinquished property and acquiring the replacement property. The QI holds the proceeds during this time until the replacement property is purchased within the 180-day completion period.

Reverse Exchange

A reverse exchange, also known as a “forward exchange” or “exchange-last,” is a less common but valuable option for investors. In this scenario, you acquire the replacement property before selling the relinquished property. To comply with IRS regulations, an Exchange Accommodation Titleholder (EAT) holds the replacement property until the relinquished property is sold.

Improvement (Construction) Exchange

In an improvement exchange, you can use the deferred tax funds to make improvements or additions to the replacement property. It’s best to use this type of exchange when you need to enhance the value of the replacement property to meet your standards.

Common Mistakes in 1031 Exchange

The 1031 exchange process can be delicate and demanding, and there are common pitfalls that you should be aware of to avoid costly errors and ensure a successful exchange. Here are common mistakes to avoid in a 1031 exchange.

Identification Issues

Identifying ineligible replacement properties, exceeding the number of properties allowed, or ambiguous and incomplete identification details can disqualify the exchange. Hence, you must thoroughly research and assess potential replacement properties before you engage the process.

Missing Deadlines

Failing to meet the strict timelines for identifying replacement properties (45 days) and completing the exchange (180 days) can lead to disqualification and immediate tax liability. You should work closely with a Qualified Intermediary and other professionals to stay on track with the exchange timeline.

Receiving “boot” and its implications

Receiving “boot,” which refers to non-like-kind investment property or cash, can trigger taxable gain in a 1031 exchange. While it is possible to receive boot in an exchange, you should be cautious about its tax implications and consider consulting tax advisors to make informed decisions.

1031 Exchange and Tax Implications

By deferring capital gains taxes, investors can retain all of their investment proceeds, allowing for greater purchasing power in acquiring replacement properties. However, a 1031 exchange does not eliminate tax; it defers it. So, you’ll still have to pay the appropriate taxes when you sell the properties you acquired as the replacement properties.

The investor’s cost basis in the replacement property is adjusted based on the gain deferred from the relinquished property. To calculate the basis in the replacement property, investors must carry over their adjusted basis from the relinquished property and add any additional cash paid for the replacement property.

A 1031 exchange can also have implications for estate planning. When an investor passes away while holding a replacement property acquired through a 1031 exchange, their heirs receive a “stepped-up” basis. This means that the basis of the investment property is adjusted to its fair market value at the time of the investor’s death. As a result, the deferred capital gains tax.


Maximizing the tax deferral benefit of the 1031 exchange is a good way to boost your purchasing power and gain flexibility on your property investments. Without the immediate burden of tax, you can easily adjust your investments to adapt to changing market conditions, capitalize on emerging investment opportunities, and optimize your real estate holdings based on your financial objectives.

If you’re considering a 1031 exchange, get in touch with a competent qualified intermediary for a smooth and successful process. Universal Pacific 1031 Exchange can help you navigate the complexities of the process, provide valuable insights, ensure compliance with IRS regulations, and help structure successful 1031 exchanges with minimal tax implications.

About The Author

Michael Bergman, CPA
Michael Bergman is a California licensed CPA and Real Estate Broker with over 32 years of experience in commercial real estate. Specializing in 1031 tax-deferred exchanges and financial oversight, his expertise is invaluable for complex real estate transactions. Michael’s unique blend of financial acumen and real estate knowledge positions him as a trusted advisor in the industry, offering sound advice and strategic insights for successful property management and investment.

Don’t let taxes hinder your property investment decisions. Connect with us today for a free, no-obligation 1031 exchange consultation. Let us help you navigate the process with ease.