1031 Exchange Rules - the Basics

(c) Copyright 2006 by Mark Hayes

What you are about to read is by far the simplest list of 1031 exchange rules you will find. The basic requirements for a 1031 exchange to take place can be summarized into six points:

1. The real estate property to be 1031 ‘exchanged’ must be for business use or held for investment.

The Internal Revenue Code (IRC) Section 1031 states that for a valid 1031 exchange the real estate property must be for business use or for investment. The definitions of ‘business use’ and ‘for investment’, however, are quite broad.

2. In a 1031 exchange, the price of the replacement real estate property must be no less than the value of the relinquished property.

You can replace your existing real estate property with any number of properties as long as the total value of the replacement properties is equal or more than the value of the property you are relinquishing. This is a very good thing since you can sell many small properties to replace with one large property or sell a large piece of real estate to acquire many smaller real estate without paying capital gains taxes. The IRS does not care about the number of properties you are selling or replacing. The IRS only cares about the total value of the replacement properties being equal or exceeding the total value of the properties you are replacing.

3. The new mortgage on the replacement property must be equal or higher than the old mortgage on the relinquished property.

No matter how many properties you are exchanging, the total amount of the new mortgage(s) on all of the replacement properties must be the same as or more than the combined loan(s) of the relinquished properties. Now, if the new mortgage(s) are less than the old mortgage(s), you can still do the 1031 exchange. However, you will owe the IRS taxes on the difference. The difference resulting from the new mortgage(s) being collectively lower than the old mortgage(s) are called mortgage relief or mortgage boot. All you really need to remember is that you will get a tax bill from the IRS if this is your case.

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