The Real Estate Agent’s Guide to 1031 Exchange Opportunities

Author: Mike Brady, Esq., CES®

The TL;DR Version

Is your client considering a 1031 exchange for their real estate? This may allow them to sell one qualifying property and buy a like-kind replacement while deferring capital gains tax. Real estate agents who spot these opportunities at listing intake can help preserve the client's deferral, often earn the replacement-property assignment, and can help clients decide whether a 1031 conversation makes sense.

Should Your Client Consider a 1031 Exchange?

A 1031 real estate exchange may be worth discussing when a client plans to sell a property that has been held for investment or business use and wants to reinvest the proceeds into another qualifying, or “like-kind”, property. 

For real estate agents, the key is not to provide tax or legal guidance, but to recognize when a transaction may call for a conversation with a qualified intermediary. So, what should you be on the lookout for when a client is selling real estate?

1. They’re selling a rental property: This may be a good time to consider whether a 1031 exchange makes sense, especially if your client hopes to boost their buying power.

2. They want to buy another investment property: A 1031 exchange could be worth exploring if your client wants to avoid an immediate tax liability.

3. They’re concerned about capital gains taxes: If points 1 and 2 apply to your client, a 1031 exchange may be worth discussing with their tax advisor and a qualified intermediary.

4. They want to grow their portfolio: A 1031 exchange may help your clients keep more capital invested in real estate.

5. Their investment goals have shifted: If your client’s goals have changed, a 1031 exchange may be worth considering as part of the sale.

Ultimately, timing is critical when considering 1031 exchanges for real estate. Be sure to discuss their options in any of the five scenarios above.

How Does a 1031 Exchange for Real Estate Work?

For real estate agents, the most important thing to understand about the 1031 exchange rules for real estate is this sequence: the exchange must be set up before closing, the proceeds cannot go directly to the client, and strict IRS timelines apply.

Here are the typical steps:

1. Your client sells a qualifying property: In a 1031 exchange for real estate, the relinquished property must be held for investment or business use, not a primary residence.

2. A Qualified Intermediary holds the proceeds: The QI, such as First American Exchange Company, helps preserve the exchange by holding the funds.

3. Your client identifies a replacement property: This must be done within 45 days of the sale of the relinquished property.

4. Your client closes on their new property: 1031 exchange rules for real estate state that this must be accomplished within 180 days.

5. The exchange is reported to the IRS: Your client must report the exchange using Form 8824 when filing their taxes.

For real estate agents, the takeaway remains the same: timing and coordination are crucial. If a client may want to use a 1031 exchange, the Qualified Intermediary should be involved before the sale closes.

Are 1031 Exchanges Only for Real Estate?

Yes. Section 1031 generally only applies to real property. Before 2018, some personal property could qualify, but the Tax Cuts and Jobs Act changed the rules.

That does not mean a 1031 exchange is limited to commercial properties. Residential real estate may also qualify if it is held for investment or business purposes. For example, rental homes, multifamily properties, vacation rentals, and certain land holdings may be eligible if they meet the applicable requirements.

For real estate agents, the key distinction is how the property is used, not simply what type of property it is. A client selling a primary residence generally would not qualify for a 1031 exchange for that sale, but a client selling a rental property, investment property, or business-use property may want to explore whether an exchange fits their strategy.

What Should You Say to a Client Considering a 1031 Real Estate Exchange?

You can play a valuable role in helping your client evaluate their options. Asking the right questions starts with understanding your client’s goal:

For the Curious Seller: “Since you’re selling an investment property, a 1031 exchange may be worth considering. It can allow you to reinvest in another qualifying property while deferring capital gains taxes, which may help keep more of your sale proceeds working for you. 

It is not the right fit for everyone, but it is worth looking at before you make a final decision. One very important thing to know is that a 1031 exchange has to be set up before the sale closes, so timing matters. If you think you may want to buy another investment property, even if you are still deciding, we should at least explore the option now. 

I can help coordinate the real estate side, and your tax advisor can help you understand how a 1031 exchange might apply to your specific situation. A qualified intermediary can also walk you through the exchange process and deadlines. That way, you can compare your options and decide what makes the most sense for your goals.”

For the CPA-first client: “That’s a great conversation to have with your CPA, and I’d want them involved before you make a decision. From the real estate side, the main thing to know is that a 1031 exchange needs to be planned before closing, and a qualified intermediary has to be involved. 

If the sale closes and you receive the proceeds, the exchange option may no longer be available. So even if you’re still waiting on guidance from your CPA, it may be helpful to explore the process with a qualified intermediary now to keep that option open. Your CPA can help you decide whether a 1031 exchange is the right move, but I want to make sure you have the information you need before timing becomes an issue.

Your CPA can help you understand the tax side, and a qualified intermediary can explain the exchange process and deadlines. I can also help coordinate the real estate pieces, like timing, contracts, and replacement-property planning. If it would be helpful, I can connect you with a Qualified Intermediary so you and your CPA can ask questions and decide what makes the most sense.”

For the Client Who Just Wants Cash: “I completely understand if your main goal is to sell and take the cash. That may be the right decision for you. I just want to make sure you know there may be another option before you decide.

If you're planning to reinvest in real estate, even if you aren’t sure yet, a 1031 exchange may let you defer capital gains taxes and keep more of your proceeds invested in your next property. The main thing is that this option has to be planned before closing, so it's important to consider it early rather than after the sale is done. 

You don’t have to commit to anything right now, but it’s worth a quick conversation with your tax advisor or a qualified intermediary to help you understand what options are available. From there, you can compare taking the cash now with reinvesting through a 1031 exchange. My goal is to make sure you have the full picture so you can choose the path that best fits your plans.”

Choosing the Right Qualified Intermediary for Your Client’s 1031 Real Estate Exchange

Choosing the right Qualified Intermediary for your client’s 1031 exchange during a real estate sale involves evaluating multiple factors. Here’s what you need to consider:

1. Experience and reputation: You’ll want to choose a QI who has extensive experience and a strong track record handling 1031 exchanges.

2. Fees and transparency: It’s important to understand the QI’s fees upfront, including whether they charge a flat rate or whether additional charges will apply.

3. Expertise with your exchange: If you’re dealing with a more complex exchange structure or a specialized property type, find a QI with expertise in that area.

4. Security of funds: Ask how the Qualified Intermediary will hold the funds from your property sale and what safeguards are in place.

At First American Exchange Company, we work with investors and real estate professionals on a wide range of 1031 real estate exchanges. If your client is ready to speak with a QI, connect with us today.

FAQs

Should I do a 1031 exchange?

A 1031 real estate exchange may be worth considering if you or your client is selling real estate held for investment or business use and plan to reinvest in another qualifying property.

What are the benefits of a 1031 exchange in real estate?

A 1031 exchange may help investors defer capital gains taxes, keep more proceeds working in real estate, increase purchasing power, diversify or consolidate a portfolio, and move into properties that better fit their long-term goals.

How does a 1031 exchange work in real estate?

1031 exchange rules for real estate require proceeds to be held by a Qualified Intermediary and a replacement property to be purchased within 180 days. The exchange must be filed with the IRS under Form 8824.

Is a 1031 only for real estate?

Yes. For exchanges completed in 2018 and later, Section 1031 applies only to exchanges of real property held for business or investment use.

Does a 1031 exchange work for residential real estate?

Yes, residential real estate may qualify if it is held for investment or business use, such as a rental property. A primary residence generally does not qualify as 1031 exchange property.

How should a real estate agent explain a 1031 exchange to a client?

An agent can explain that a 1031 exchange may allow an investor to sell one qualifying property and reinvest in another while deferring capital gains taxes. The agent should avoid giving tax or legal advice and instead encourage the client to speak with a tax advisor and a Qualified Intermediary.

When should a real estate agent bring up a QI?

A real estate agent should bring up a qualified intermediary as early as possible, ideally before the sale closes. If the client receives the sale proceeds directly, the exchange may no longer qualify.

Can a 1031 exchange be used for a REIT?

Typically, a direct investment in a REIT does not qualify for a standard 1031 exchange because REIT shares are securities, not direct real property.

What happens if my client misses the 45-day deadline?

If the client misses the 45-day identification deadline, the exchange generally fails, and the sale may become taxable. Agents can help by encouraging clients to start planning early.