One of the most powerful tools available to real estate investors in the United States is the 1031 Exchange. While the name comes straight from the tax code, its benefits are anything but dry: it allows investors to defer capital gains taxes when selling investment or business property, as long as they reinvest the proceeds into another qualifying property.
In a recent episode of SoCal Multifamily Insights, host Jack Patel sat down with Jordan Phillips of IPX 1031 to break down how the exchange works, what timelines investors need to follow, and the common pitfalls that can derail a deal.
What Is a 1031 Exchange?
At its core, a 1031 Exchange is the “greatest wealth preservation tool in the tax code,” as Jordan explains. Instead of paying hefty capital gains taxes—often close to 40% in California when federal and state rates are combined—investors can defer those taxes and roll their gains into another investment property.
This means more money stays working for the investor, compounding over time through additional cash flow, appreciation, and depreciation benefits.
The Role of the Qualified Intermediary (QI)
One of the most misunderstood aspects of a 1031 Exchange is the role of the Qualified Intermediary (QI). The IRS requires that an independent third party, like IPX 1031, hold the funds between the sale and purchase.
Without a QI, the exchange is invalid. If the seller touches the funds—even briefly—the transaction becomes taxable. This is why setting up the exchange before the property closes is crucial. As Jordan emphasizes, the worst call he receives is from an investor saying, “I closed yesterday—can I still set up an exchange?” The answer, unfortunately, is always no.
Key Deadlines: 45 and 180 Days
The IRS doesn’t make the process effortless. Investors must follow two critical deadlines:
- 45 Days to Identify: After selling the property, the investor has 45 calendar days to formally identify replacement property (or properties). The IRS offers two rules:
- Three-Property Rule: Identify up to three properties of any value.
- 200% Rule: Identify four or more properties, as long as their combined value does not exceed 200% of the sales price.
- 180 Days to Close: Investors have 180 days from the date of sale to complete the purchase.
Miss either deadline, and the exchange fails.
What Types of Properties Qualify?
The good news is that property type is flexible, as long as the asset is considered real property and used for investment or business. That means single-family rentals, multifamily apartments, office buildings, retail, industrial, vacant land, mineral rights, billboards, and even windmills can all qualify.
However, the exchange must remain within the United States. An investor cannot sell in California and reinvest in Italy or Japan.
Debt, Equity, and “Boot”
To fully defer taxes, investors must reinvest both the equity and the debt from the sale. For example:
- If you sell for $1.5 million with $700,000 in equity and $800,000 in debt, you must reinvest the full $1.5 million.
- The $700,000 of equity must be rolled entirely into the new purchase.
- The $800,000 debt must be replaced, either through new financing or additional cash.
If an investor reinvests less, the difference is called boot, and it becomes taxable. Partial exchanges are allowed, but taxes will apply on the amount not reinvested.
Partnership Complications
Things get tricky when partnerships are involved. If multiple partners own a property, but only some want to exchange, the structure must be carefully managed.
Two common strategies are:
1. Drop and Swap: Partners exit the LLC and take fractional ownership in the real estate before selling, then decide individually whether to exchange or cash out. Risky, since tax authorities may challenge it.
2. Redemption Agreement: Some partners redeem their shares for direct property ownership before the sale, while the remaining LLC continues the exchange. This is often safer in California due to aggressive Franchise Tax Board oversight.
As Jordan notes, advanced planning is key. These structures cannot usually be fixed last-minute.
Refinancing Before or After an Exchange
Another common investor question is whether they can refinance before selling or after buying.
• Refinancing before a sale can raise red flags. If done too close to the closing, the IRS may argue that the refinance was simply a way to pocket sale proceeds, making it taxable.
• Refinancing after a purchase is typically safer and less scrutinized, as long as it occurs after the exchange is complete.
Choosing the Right Qualified Intermediary
Not all QIs are created equal. The industry is federally unregulated, meaning investors must be diligent about who they trust with potentially millions of dollars.
IPX 1031, Jordan explains, is backed by Fidelity National Financial, a Fortune 500 company that also owns major title insurance brands like Fidelity Title and Chicago Title. IPX provides layers of protection, including:
- $100 million fidelity bond
- $30 million errors and omissions insurance
- Parent company guarantees up to $50 million per exchange account
- Partnerships with major banks like Citibank and U.S. Bank
For investors, this level of financial security is a critical factor when selecting a QI.
The Takeaway
The 1031 Exchange is a proven strategy for building long-term wealth through real estate, but it comes with strict rules and deadlines. Investors must:
- Set up the exchange before closing.
- Work with a Qualified Intermediary.
- Identify replacement properties within 45 days.
- Close within 180 days.
- Reinvest all equity and replace debt to fully defer taxes.
- Carefully plan partnerships and refinancing strategies.
With the right team—including a knowledgeable QI, broker, and CPA—investors can defer taxes, grow their portfolios, and preserve wealth across generations.
As Jack Patel closes the episode: “If you’re thinking about selling and doing a 1031 exchange, don’t wait until the last minute. Plan ahead, get the right advisors, and do it correctly.”
👉 Reach out to Jordan Phillips at 442-287-7239
👉 Reach out to Jack Patel at 213-453-2572
