Can You Buy Multiple Properties in a 1031 Exchange?
If you’re looking to invest in real estate or sell your investment property to invest in another, a 1031 exchange could be an excellent option.
One question often arises is whether you can buy multiple properties in a 1031 exchange.
The short answer is yes, you can buy multiple properties in a 1031 exchange. There are some rules and guidelines that you need to follow to ensure that your exchange is valid and doesn’t trigger any taxes.
What is a 1031 Exchange?
A 1031 exchange, a like-kind exchange, is a tax-deferred exchange that allows you to sell a property and reinvest the proceeds into another property without paying capital gains taxes.
The IRS allows you to defer these taxes as long as you follow their guidelines and rules for the exchange.
The goal of a 1031 exchange is to help you grow your investment portfolio by reinvesting your profits into new properties.
The Rules of a 1031 Exchange
To participate in a 1031 exchange, there are some strict rules and guidelines that you need to follow. These include:
- The properties involved in the exchange must be like-kind, meaning they are exact, character, or class.
- The exchange must be completed within 180 days from the sale of your original property.
- It would be best to use a qualified intermediary to facilitate the exchange.
- The money from the sale of your original property must be held in escrow until the exchange is complete.
- You must identify the replacement property or properties within 45 days of the sale of your original property.
Buying Multiple Properties in a 1031 Exchange
Now that we’ve covered the rules of a 1031 exchange let’s talk about how you can buy multiple properties in a 1031 exchange.
The first thing you need to do is identify the replacement properties you want to purchase. You must identify these properties within 45 days of the sale of your original property.
You can identify up to three replacement properties or more if you follow the 200% rule.
The 200% rule allows you to identify more than three replacement properties as long as the total fair market value of the properties identified does not exceed 200% of the property you sold.
Once you’ve identified your replacement properties, you can purchase them using the proceeds from selling your original property.
You can purchase multiple properties as long as they meet the like-kind requirement and the total cost does not exceed the sale amount.
Can I Use Heloc to Buy Another Property?
Things To Remember When Buying Multiple Properties in a 1031 Exchange
Here are some things to remember when buying multiple properties in a 1031 exchange:
Meet the time limits: You have 45 days after selling a property to identify replacement properties and 180 days after selling to complete all purchases of replacement properties.
Buy properties of equal or more excellent value: To entirely defer capital gains taxes in a 1031 exchange, the total value of the replacement properties must be equal to or greater than the value of the relinquished property you sold.
Purchase costs can be grouped: You can allocate purchase costs across multiple replacement properties to meet minimum value requirements.
Buy like-kind properties: The replacement properties must be “like-kind”, meaning similar types of investment properties – residential for residential, commercial for commercial, raw land for raw land, etc.
Consider debt allocation: If you have mortgage debt secured by the relinquished property, you’ll need to allocate some of the debt to each replacement property to avoid partial taxability of the exchange.
Watch depreciation recapture: Any depreciation recapture taxes related to the relinquished property cannot be deferred via a 1031 exchange.
Stay consistent with title: The title to your replacement properties must be consistent with the relinquished property – put all in your name or use the same entity (LLC, corporation, etc.).
Pros & Cons
Here are some pros and cons of buying multiple properties in a 1031 exchange:
Pros:
Diversification – You can diversify your real estate portfolio by acquiring different types of properties in different locations. This reduces risk.
Economies of scale – Managing multiple properties can result in economies of scale with property management, maintenance, and operations.
Increased cash flow – Owning multiple income-producing properties can provide a more significant monthly cash flow stream.
Leverage – Using mortgage financing on multiple properties can amplify your returns on investment.
Cons:
Higher debt – Taking on mortgages for multiple properties results in higher overall debt.
Increased management – Managing and overseeing multiple properties takes more time and effort.
Higher expenses – Owning multiple properties means higher overall operating expenses like insurance, taxes, repairs, and maintenance.
Concentrated risk – While diversification reduces some risk, all your properties are still concentrated in the same real estate sector and potentially the exact location.
Complexity – Complying with the rules for a proper 1031 exchange becomes more complex with multiple property purchases.
Vacancy risk – The more rental properties you own, the higher the chance that some will experience vacancies, impacting your cash flow.
How many times can you use the 1031 exchange?
There is no limit to how many times you can use a Section 1031-like-kind exchange to defer capital gains taxes on real estate.
Theoretically, you could do a 1031 exchange indefinitely to continue rolling the deferred gains into new replacement properties.
There are a few things to keep in mind:
Each 1031 exchange transaction has costs – legal fees, accounting/tax fees, brokerage commissions, etc. These add up over time.
Complexity increases with each exchange – more properties under management, debt, tax compliance requirements, etc.
Eventually, you will want or need to realize some of the gains – may be to diversify into other investments, take gains for living expenses in retirement, or pass gains onto heirs.
The 1031 exchange rules could change – Congress could amend or eliminate Section 1031 in the future, limiting its effectiveness.
So while there is no explicit limit on the number of 1031 exchanges someone can do, there are practical considerations that may lead you to take some gains at various points.
The 1031 exchange is a tax deferral strategy, not a permanent tax avoidance.
For most real estate investors, using 1031 exchanges periodically – maybe every 5 to 10 years – to reposition and grow their portfolios makes the most sense.
This allows you to benefit from tax deferral but not take on an unsustainable level of debt, complexity, and management needs that come with doing an exchange every 1 to 2 years.
FAQs
What is a 1031 exchange?
A 1031 exchange is a tax-deferred exchange that allows you to sell a property and reinvest the proceeds into another property without paying capital gains taxes.
Can you buy multiple properties in a 1031 exchange?
Yes, you can buy multiple properties in a 1031 exchange as long as they meet the like-kind requirement and the total cost of the properties does not exceed the sale amount.
What are the rules of a 1031 exchange?
The rules of a 1031 exchange include using a qualified intermediary, identifying replacement properties within 45 days, and completing the exchange within 180 days of selling your original property.
Conclusion
A 1031 exchange can be a great way to grow your investment portfolio and avoid paying capital gains taxes.
If you’re considering buying multiple properties in a 1031 exchange, follow the rules and guidelines set forth by the IRS.
You can purchase multiple properties and defer your taxes by working with a qualified intermediary and identifying your replacement properties within 45 days.