What Are 1031 Like-Kind Exchanges, and How Do They Help?

“Pennsylvania’s recognition of 1031 like-kind exchanges leveled the playing field for Pennsylvania investors,” said Margo McDonnell, president and CEO of 1031 CORP., on PAR’s webinar yesterday. 

Three years ago, Pennsylvania became the last state to recognize 1031 exchanges, with the recognition becoming Act 53 of 2022, thanks to PAR’s lobbying efforts. Since 2023, this tax deferral has become a beneficial option for consumers across the state, as well as a way for Realtors® to further help their clients. 

Still, many people don’t know what a 1031 is, how it works or the benefits of using one. 

What is a 1031 like-kind exchange? 

“A 1031 exchange gets its name from Section 1031 of the Federal Tax Code,” McDonnell explained. “It allows the owner of any type of business-use or investment real estate to exchange it for another piece of or type of business-use or investment in real estate.” 

“Any kind of property can be mixed and matched. One of the biggest misconceptions with 1031 exchanges is that word ‘like-kind.’ People think it’s very restrictive, meaning you have to buy the same type of property. I tell everyone that’s what creates the flexibility of 1031, because like-kind refers to the nature or the character of the property, not the specific type of property. So, you can mix and match any type of property held for business use or investment anywhere in the U.S. You can sell more than one, buy more than one – there’s so much flexibility.” 

“It’s really a way for investors to further gain when selling one property, and roll that gain into the next,” she added.” 

What are the benefits of using one? 

1. Time value. McDonnell said, “Rather than writing the check now, we get to take that money and reinvest it, so there continues to be appreciation on those funds for you.” 
2. Greater buying power. “You have more money to reinvest,” she explained. 
3. Ability to diversify or consolidate. 
4. Unlimited number of times you can exchange. “The IRS is keeping track of how much you’ve deferred along the way, because it’s just rolling into that next property. If you do an outright sale without doing a subsequent exchange, that is when the tax comes due. But if you never sell that last property, when you pass away, your heirs inherit that property with a step-up in basis. Meaning, they inherited at the current fair market value at the time of death, and all that gain was deferred is forgiven at the time of death. And, under the current estate tax rules, the first 13.99 million of someone’s estate is exempt from estate taxes.” 

“So, 1031 is a way to build wealth, preserve your equity and potentially pass it to your heirs without any federal tax liability,” she summed up. 

How can Realtors® help their clients take advantage of 1031s? 

McDonnell shared that one of the biggest misconceptions about 1031s that she regularly encounters is that they are limited to commercial transactions. But that’s not true. 

“What most people don’t realize is the most frequently exchanged type of property in the U.S. is a single-family rental,” she noted. “More than 60% of all 1031s involve just a single-family rental, and while you may never sell commercial property, almost every residential agent runs into an investment property along the way – that single-family rental.” 

“Letting your clients know about the possibility of doing a 1031 exchange allows you to be the hero, right? It opens their eyes to the idea that they don’t have to pay the tax right now; they could roll it into another property. And it gives you the ability to add value and become their agent for life, which is something everybody strives for.” 

Is it a difficult process? 

“I tell people it’s much easier than they think it is,” McDonnell assured. “One of the things that Section 1031 does is it requires the use of a qualified intermediary, and a qualified intermediary – or QI – is an independent party who hasn’t acted as an agent of the taxpayer or the exchanger in the last two years. So, not the real estate professional, their attorney, their accountant, a close relative, an employer or partner.” 

“But the qualified intermediary, while yes, they act as the unofficial police of the IRS, they’re there to educate the client and hold their hand throughout the whole process. So it is a really easy transaction for them. The qualified intermediary will pair all the necessary documentation and coordinate with the closing agents on both ends of the deal.” 

While McDonnell can’t speak for all qualified intermediaries, she shared that 1031 CORP. also holds the exchange proceeds in interest-bearing accounts and makes sure their clients have 100% FDI insurance and safeguards on those funds. 

How can Realtors® use 1031s to create more business? 

“It’s a competitive edge, knowing about 1031s and being able to recognize the opportunity,” she emphasized. “The 1031 will allow Realtors® to have just another feather in their cap, and these days people are looking to interview multiple agents. To be able to bring that up right when you’re taking the listing is a huge benefit to you. It shows that you’re not just a random transaction-driven professional, but that you’re really looking to build a relationship where you are adding value and want to be their trusted advisor for life.” 

For Realtors® looking to learn more about 1031s, McDonnell recommended taking continuing education classes and reading resources online (such as the National Association of Realtors®’ resources). Realtors® can also promote 1031s to their clients through social media, postcards, blog posts and more. 

“No one expects you to be an expert on 1031s, but to be an expert on recognizing the opportunity for your clients,” she said. 

As a Realtor®, when should you bring up 1031s to your client? 

“I always tell people to start talking about 1031s when you take the listing. When you sign the Agreement of Sale, that’s when it’s time to have that serious conversation about 1031s.” 

McDonnell noted that, in a transaction, the client should talk to their tax advisor about the tax consequences of the sale. At that time, the Realtor® should try to identify the type of property that they’re interested in, so they can be working the time that they have between entering into the agreement of sale with the buyer and closing. 

“Once closing happens, they only have 45 days to identify the property,” she reminded. “But we all know that it takes 30-45 days to close on a property, generally, so that’s 30-45 days you have before there’s any time clock ticking.” 

She also shared that she’s currently seeing the shortest amount of time ever between the day clients sell their old property and the acquisition of the new one. 

Three cardinal rules. 

McDonnell’s three cardinal rules when it comes to 1031 exchanges are: 

1. Buy something for equal or greater value. 
2. Have equal or greater equity. 
3. The same owner has to buy the new property. 

What are the other rules? What about a reverse 1031?  

For more extensive details and McDonnell’s answers to Realtor®-asked questions, view the webinar recording.