Types of Exchanges
If you’re considering investing in real estate, a 1031 exchange can be a powerful tool for maximizing your returns. A 1031 exchange allows you to defer paying taxes on the sale of an investment property if you use the proceeds to purchase another investment property. This means you can reinvest your money without taking a tax hit, which can help you grow your portfolio more quickly.
There are several different types of 1031 exchanges, each with its own set of rules and requirements. On this page we’ll explore the most common types of 1031 exchanges and help you determine which one might be right for you.
| Best for | Order of closings | Hardest part | |
|---|---|---|---|
| Delayed | Most sales. The default structure | Sell, then buy | Finding the right property inside 45 days |
| Simultaneous | Both parties ready to close together | Same day | Getting two closings to land on one date |
| Reverse | A replacement property you cannot risk losing | Buy, then sell | Financing, and the 180-day parking cap |
| Improvement | A building worth less than you sold, but not after renovation | Sell, then buy and renovate | Finishing the work inside 180 days |
| Construction | Building exactly what you want on land you acquire | Sell, then buy land and build | Almost no ground-up build finishes in 180 days |
| Partial | Taking some cash out and accepting the tax on it | Usually sell, then buy | Knowing the real tax cost of the boot in advance |
Delayed Exchange
A delayed exchange is the most common type of 1031 exchange. In this scenario, you sell your existing property and then have 45 days to identify a replacement property. You then have 180 days to close on the replacement property.
The advantage of a delayed exchange is that it gives you more time to find the right property. You can take your time to search for a property that meets your investment goals and avoid rushing into a purchase.
However, the delayed exchange also requires careful planning and execution. You’ll need to work with a qualified intermediary to hold your proceeds and ensure that the exchange meets all the requirements of the IRS.
Simultaneous Exchange
A simultaneous exchange is the most straightforward type of 1031 exchange. In this scenario, you sell your existing property and purchase a new one on the same day. This allows you to defer taxes on the sale of your old property and immediately reinvest your proceeds into a new property.
The main advantage of a simultaneous exchange is that it’s more simple and easy to execute than the other exchange types. However, it can be challenging to find two properties that are a good match for each other and complete the transaction on the same day.
Reverse Exchange
In a reverse 1031 exchange you secure the replacement property before you sell. An Exchange Accommodation Titleholder holds title to one of the two properties while you complete the other side of the transaction.
This is the structure for a property you cannot afford to lose while you wait for a buyer. It is also the most demanding: the combined parking period cannot exceed 180 days, and financing is harder because the lender is lending to the titleholder entity rather than to you.
Improvement Exchange
An improvement 1031 exchange lets you use exchange funds to renovate or expand a building you are acquiring, and to count that work toward the value you must reinvest. It is the answer when the property you want is worth less than the one you sold but would be worth more with money put into it.
It uses the same parking structure as a construction exchange and the same 180-day deadline, but the odds are far better, because most of the building’s value is already standing on day one. You cannot use it on property you already own.
Construction Exchange
A construction 1031 exchange, also called a build-to-suit exchange, lets you use your exchange funds to build on land you are acquiring. An Exchange Accommodation Titleholder takes title while the building goes up, and you receive the finished property to complete your exchange.
The appeal is obvious: you get exactly the building you want rather than the closest one on the market. The constraint is severe. Only construction physically completed within 180 days counts toward your reinvestment, and most ground-up projects do not get there. If you already own the land, this structure is not available to you.
Partial Exchange
A partial 1031 exchange is a type of real estate transaction that allows a property owner to defer paying taxes on a portion of the capital gains from the sale of their property. In a partial 1031 exchange, the property owner can choose to reinvest some of the proceeds from the sale into a new property, while taking the remaining proceeds as cash. Cash you keep, and any reduction in debt, is treated as boot and is taxable up to the amount of your gain, with depreciation recapture taxed first and at a higher rate.
This allows the property owner to partially defer their tax liability and potentially maximize their investment returns. However, it is important to work with a qualified intermediary and follow all IRS rules and regulations to ensure a successful partial 1031 exchange.
Frequently Asked Questions
How many types of 1031 exchange are there?
There are six commonly used structures: delayed, simultaneous, reverse, improvement, construction, and partial. They differ in the order of the closings and in whether a third party holds title to a property during the exchange. All of them share the same 45-day and 180-day deadlines.
Which type of 1031 exchange is most common?
The delayed exchange, by a wide margin. You sell the relinquished property, a Qualified Intermediary holds the proceeds, you identify replacement property within 45 days, and you close within 180 days. Every other structure is a variation for a situation the delayed exchange cannot handle.
Do all types of 1031 exchange require a Qualified Intermediary?
In practice, yes. If you take possession of your sale proceeds at any point, you have constructive receipt and the exchange fails. That is true even in a simultaneous exchange where both closings happen on the same day.
Which type of 1031 exchange is hardest to complete?
Construction exchanges, because nearly all of the property’s value has to be created inside 180 days. Reverse and improvement exchanges are also demanding, since both require a third party to hold title and both run against the same deadline.
Can I change exchange types after I have started?
Only in one direction. A full exchange can become a partial exchange simply by ending up with boot, though that is rarely a decision anyone makes on purpose. You cannot convert to a reverse or parking structure after your property has sold, because those have to be set up before the closing.
Not Sure Which Type of 1031 Exchange You Need?
Every one of these structures runs on the same two deadlines, and every one of them has to be set up before your relinquished property closes. If you are weighing a sale, the useful conversation happens before you have a signed contract, not after. Read the 1031 exchange rules and requirements that apply to all six, or contact our team and we will tell you which structure your situation actually calls for.