For property owners considering the sale of an investment property, the 1031 Exchange, named after Section 1031 of the IRS tax code, offers a powerful way to defer capital gains taxes and preserve investment momentum. While it’s often misunderstood, this strategy can be a valuable financial tool, particularly in a real estate market like the Lowcountry’s, where property values have seen significant appreciation in recent years.
At its core, a 1031 Exchange allows an investor to sell one investment property and reinvest the proceeds into another, deferring the capital gains taxes they would normally owe on the sale. The term “like-kind” is often used to describe the transaction, but it’s more flexible than many assume.
According to Michael Fleenor, CPA at Robinson Grant,
“It’s not just a swap of a similar type of real estate (i.e. a short term rental villa for another short term rental villa). It’s about exchanging real estate that serves a similar investment intent.”
Investors can exchange a long-term rental home for a vacation rental, a condo for vacant land, or even commercial property, as long as the replacement asset is also held for investment or business use.
Vacation Properties Can Qualify for a 1031 Exchange
One of the more common questions in our market involves second homes and vacation rentals. Fleenor clarifies that vacation properties can qualify for a 1031 exchange, but owners must be mindful of personal use limitations.
“Generally, the owner cannot use the property for more than 14 days a year or 10% of the time it’s rented out,” he says. “Exceeding that could disqualify the property.”
Two Key Deadlines
There are two key deadlines every 1031 investor needs to track. Once the sale of the original (or “relinquished”) property closes, the clock starts ticking. Within 45 days, the seller must identify a replacement property. Then, they have 180 days total from the date of recording on the relinquished property to close on the new property.
Rules for Proceeds
Another essential rule is that the seller cannot take possession of the proceeds from the sale. Those funds must be held by a Qualified Intermediary (QI), a neutral third party that ensures compliance with IRS rules.
“If you touch the money, you’re taxed,” says Fleenor. “It has to go straight from the sale to the QI and then into the new property. That’s a critical step in preserving the tax-deferred status.”
Advanced Strategies and Benefits
There are also more advanced strategies, such as reverse 1031 exchanges, where the investor purchases the replacement property before selling the original.
“Though more complex and costly, a reverse exchange allows for flexibility in hot markets when timing doesn’t line up,” Fleenor explains.
In this case, a temporary LLC may be used to hold the new property until the original is sold.
One long-term benefit of 1031 exchanges is the ability to defer taxes repeatedly, by continually rolling investments into new properties. In some cases, Fleenor notes,
“That property can eventually be passed to your heirs with a step-up in basis, potentially eliminating the capital gains tax liability altogether.”
This strategy is ideal for landlords, business owners, and real estate investors who want to grow their portfolios without triggering a taxable event. Whether you’re trading up to a larger asset or repositioning your holdings, a 1031 exchange gives you more control over timing and tax outcomes.
Of course, this is not a DIY endeavor. Anyone considering a 1031 exchange should work with both a CPA and a Real Estate Specialist who understand the process, the rules, and the local market. When executed properly, a 1031 exchange is one of the most powerful tools available to investors in real estate.
Chip Collins, Owner, Broker in Charge, and Listing Specialist at Collins Group Realty
Michael E. Fleenor, CPA, ABV, at Robinson Grant & Co., specializes in tax strategy and business valuation. He is licensed in South Carolina, Virginia, and Tennessee.