1031 Exchange Basics for Houston Investors

A 1031 exchange lets you sell an investment property and defer the federal tax on your gain by reinvesting in other investment real estate. Texas has no state income tax, so for most local investors the federal tax is what is being deferred.

Most exchanges that fail do so for one reason: the planning started too late. These are the five questions I ask my clients to answer before their property is listed.

1. Does my property qualify?

Both the property you sell and the one you buy must be real estate held for investment or business use. Rental houses, apartment properties, commercial buildings, and land held for investment generally qualify. Your own home does not, and neither does property bought to fix up and resell quickly.

2. Who is my qualified intermediary?

You cannot receive the sale proceeds yourself, even for a day. An independent company called a qualified intermediary must hold the money between your sale and your purchase. This must be arranged before your sale closes. Choosing the intermediary is a decision to make with your CPA, and I can coordinate with whoever you select.

3. What will I buy?

Decide on the type of property, price range, and location before you sell. Investors often use an exchange to move from rental houses into commercial property, apartments, or a net lease investment that needs less management. Knowing your target lets me start searching early.

4. Can I meet the deadlines?

Two deadlines begin the day your sale closes:

• —45 days to identify replacement properties in writing
• —180 days to close on the replacement property

Neither can be extended. In practice, 45 days is short, which is why I begin looking for replacement property while your sale is still pending. Closing dates on both transactions can also be negotiated to give you more room.

5. How much do I need to reinvest?

To defer all of the tax, you generally need to buy property worth at least as much as the one you sold and reinvest all of the proceeds. Cash you take out, or a loan you pay off and do not replace, is generally taxable. Your CPA can calculate exactly what you need to reinvest.

Putting it together

A well-run exchange usually follows this order:

• —Speak with your CPA about whether an exchange suits you
• —Choose a qualified intermediary
• —Define what you want to buy
• —List and sell your property, with exchange language in the contract
• —Identify replacement property within 45 days
• —Close within 180 days