1031 Exchange Basics Every Portland Investor Should Know

If you’ve spent any time looking at investment real estate, you’ve heard of the 1031 exchange, and there’s a decent chance the version you heard was wrong. The one I run into most is that you can take your profit from one deal and roll it into the next. People think they get to keep a little for themselves along the way. The actual rule is narrower. You have to be selling and buying business or investment real estate in the United States, and that’s the first thing to get straight.

The money can’t touch your hands. Once you’re going down this road, you set up what’s called a qualified intermediary, which just means working with a 1031 exchange company. They take the money out of escrow when you sell and hold it, so you never touch it. When you buy, that same company transfers the funds into the new escrow. The whole point is that the proceeds never land in your account.

Start before you list the property. My strongest recommendation here has nothing to do with paperwork. Before you even list, meet with a 1031 company or qualified intermediary. Get familiar with the rules, make sure your specific situation will work, and find out whether you need to handle anything before you sell. People who skip that step are the ones standing at the closing table realizing they forgot something, with a large capital gains bill now coming.

You have 45 days to identify. The sequence itself is straightforward. You list the property, you sell it, and before closing you’ll have your qualified intermediary set up with your escrow company to hold the funds. From the date of sale, you’ve got 45 days to put in writing which property or properties you’re buying. Inside those 45 days, you really want to be in contract and ideally through inspections and other due diligence. Wait too long, and you can end up forced to buy a property you identified, because the window closed before you finished looking at it.

Replace the price and the debt. Your total sales price needs to be replaced. Sell for a million, buy for a million or more. If you have debt, replace that too. Say you had a million-dollar property with a $300,000 loan on it. You could buy another million-dollar property with cash, assuming you’ve got an extra $300,000 lying around. What most people do instead is take out a new loan against their equity, and plenty of them end up leveraging up into bigger properties as they go.

Both clocks start at closing. You’ve got 45 days to identify, and you’ve got 180 days to close, and that 180 days also starts on the date of the sale. The timelines run concurrently. Day zero is the day you close on the property you’re getting rid of, which leaves 135 days to close once the identification window shuts. That matters most when you’re getting new financing. Selling a triplex to buy a 10-plex is usually quicker on the lending side. A complicated multi-tenant office, a retail property, or an industrial building takes longer. You can also use this tool for a business property you’re buying for your own business.

Deferral is not forgiveness. What the exchange does is push your capital gains into the future. If you bought a property for $500,000 and it’s worth a million now, this can be a really good tool. You get to take all of that money into the next property, or add to it, without paying the gains today. It doesn’t wipe the tax away. As long as you keep doing exchanges, or you hold that replacement property forever, the money stays invested instead of going to the IRS now, which is a huge benefit.

Sometimes paying the tax wins. I see people get genuinely worried about doing a 1031 on a property that doesn’t have much of a gain in it. If your gain isn’t substantial, the exchange might not be worth it. I’ve had clients choose to pay the taxes because they’d rather be free of the time limit and put the money into other things. It isn’t all or nothing either. You can reinvest most of the proceeds and keep some, which they call boot, though you’ll pay taxes on that piece. Or you take the gain, pay the tax, and put it into the stock market, into bonds, or into cash while you wait for the right opportunity to buy.

The right deal rarely waits. Sometimes that opportunity does show up inside the 45 day window. If you’ve done this before, though, you’ve probably wished you had a year to find the next property. That’s especially true for a business, where location and style matter a lot, as opposed to an investor who’s looking for a certain return on a certain property type.

I’m including a link to one of the best resources out there on 1031 exchanges. It’s from a company based right here in Oregon, and their knowledge base is worth a deep dive. If you’re thinking about buying or selling investment property, give me a call. I’d love to talk it through and help you make a good decision for you and your future. Reach me at 503-901-8100, email me at nkrautter@gmail.com, or visit sellpdx.com. You’ll find me at Sell PDX Team, SVN - Imbrie Realty, 7150 SW Fir Loop, Suite 100, Portland, OR 97223. The earlier we start, the more options you’ll still have.