Many investment property owners hesitate to sell because of capital gains taxes. But by utilizing a 1031 exchange, you can successfully sell your rental property without incurring the tax hit. In

this article, Del Coronado Realty provides a brief guide to help you understand what a 1031 exchange is, how it works, and why it’s so valuable.

Rental Property Depreciation

When you own a rental property, you depreciate its value each year, both to deduct the costs of improving the property, and to account for wear and tear. The amount you can deduct each year is dependent on the basis (or cost) of the building (not the land). You can depreciate a property using the Modified Accelerated Cost Recovery System (MACRS) over the course of 27.5 years, which the IRS considers to be the life expectancy or “useful life” of a rental property.

Mitigate Capital Gains with a 1031 Exchange

While depreciation allows you to reduce your taxes during the time you own a rental property, you are left vulnerable to those tax obligations if you decide to sell the property. A 1031 exchange allows you to mitigate capital gains and apply them to your next property purchase so that you do not have to pay taxes on the value you have depreciated over the years. When you reinvest or “exchange” the gains into a similar property, they become tax-deferred.

1031 Exchange Timeline and Requirements

During a 1031 exchange, you have 45 days from the closing of your current rental property to identify and file three potential exchange properties. Ideally, you will enter into escrow during this time, as you have a total of 180 days to close on your new property. If these deadlines and requirements aren’t met, the IRS will deny the 1031 exchange, and you will be taxed on the capital gains from your current property. 

1031 Exchange Process

Once you have determined that you want to sell your property, you can expect the following steps: 

  • Hire a 1031 exchange accommodator to handle the funds associated with your sale.
  • Hire a realtor to advise you on the 1031 exchange process and buying your new property. Be sure to let them know that you wish to do a 1031 exchange.
  • Disclose to potential buyers that you are doing a 1031 exchange. (There will be no cost to them, but you still need to make them aware.)
  • Upon closing, the accommodator will hold on to the funds until you find your next property.
  • Identify three properties within 45 days of closing.
  • Choose one of the three properties and close within the exchange period of 180 days from the closing date of your current property.
  • At closing, the accommodator will utilize the funds from the sale of your previous property.

Avoid Common 1031 Exchange Mistakes

The nuances and line items that come with a 1031 exchange can be confusing to investors, especially those who have not yet done a 1031 exchange. A few quick tips to ensure that you do not mishandle and negate your exchange:

  • Do not try to complete a 1031 exchange without an accommodator. Once you touch the money from the sale of your current property, it becomes taxable.
  • Do not try to switch to a different property than one of the three you have already identified.
  • Do not miss the 45-day and 180-day windows.


Use a 1031 Exchange to Expand Your Portfolio

The main benefit of doing a 1031 exchange is that you increase your buying power. Capital gains taxes can be crippling to investors, which is why the IRS provides protection for those who seek to continue investing.

Here in Coronado, the combination of rapid appreciation and the ability to defer capital gains is a recipe for a healthy, growing, and diversified portfolio of rental properties. From the sale of your current property, you might be able to buy several new properties and increase your rental income stream.


Work with an Experienced Realtor

A 1031 exchange is a great opportunity to have the tax system work for you, whereas it would otherwise work against you. In order to meet the finite requirements, though, it’s important that you hire a realtor who understands how to complete a 1031 exchange.


If you’re looking to do a 1031 exchange with your Coronado rental property, look no further than Del Coronado Realty. We can help you sell your property and find a new property, without being subject to additional taxes. Call us at 619-437-1888, or visit our offices in the iconic Hotel del Coronado at 1500 Orange Avenue.