In order to conduct a 1031 exchange—and safely navigate the complexities of the relevant provisions of the Internal Revenue Code—you should either (1) have a sophisticated understanding of the portions of the United States Code governing 1031 tax-deferred exchanges or (2) find a qualified professional to assist you. Because tax laws change and new tax regulations are issued periodically, your best bet for a successful 1031 exchange is to enlist the help of a professional.
A key aspect of a 1031 exchange is that you are not simply selling one property and then using the proceeds from that sale to buy another. Rather, the selling of the relinquished property and buying of the replacement property is conducted as one transaction. To achieve this, you will generally use what is known as a "Qualified Intermediary"—a third party that will handle the funds throughout the exchange—to conduct the transaction.
Find a buyer for the property you wish to sell. This property—commonly referred to as the "relinquished property," because this is the property you will be giving up in exchange for another—is the property you will be exchanging for another in this transaction in order to defer capital-gains taxes.Your next step, then, is to find someone who is willing to purchase your property at the amount at which you wish to sell it.
Once you have identified a Qualified Intermediary you wish to use, you will enter into an Exchange Agreement with the Qualified Intermediary. This agreement will allow the intermediary to receive the funds from the sale of your relinquished property, hold those funds, and then eventually use them to purchase your replacement property.
This property—commonly referred to as the "replacement property," because this is the property that will be replacing your relinquished property—is the property you will be acquiring with the proceeds from the sale of your relinquished property in order to defer capital-gains taxes. You must identify the replacement property/properties in writing, sign the document, and deliver it to your Qualified Intermediary within the 45-day timeframe.
The next step is to have your intermediary enter into a sale agreement with the seller of your replacement property. Your intermediary will, according to your Exchange Agreement, use the funds it received from the sale of your relinquished property to buy the replacement property. The seller will deed the property to you, receive payment from the intermediary, and then you will receive your replacement property.
You must complete the exchange and receive title to your replacement property within 180 days of the sale of your relinquished property or the due date of the income-tax return for the year in which such property was sold—whichever date is earlier.
After you complete the exchange, in order to receive the tax-deferment benefit of the exchange, you must complete and file IRS Form 8824—Like-Kind Exchanges—in the tax year in which the exchange occurred.
A Section 1031 exchange is a product of federal law, which is why you must report such an exchange to the IRS. Certain states, such as California, also have state-reporting requirements for 1031 exchanges conducted in their territory. You will have to complete and submit an additional form in order for your 1031 exchange to comply with the laws of your state.