1031 Exchange in Texas: A Broker's Guide to DFW Replacement Property

The basics in plain terms

Under Section 1031 of the Internal Revenue Code, you can defer tax on the gain from selling real property held for investment or business use if you reinvest in other like-kind real property. “Like-kind” is broad for real estate: an apartment building can be exchanged for land, an industrial building, a retail center or another apartment community. Property held mainly for resale, such as a fix-and-flip, does not qualify, and neither does your primary residence.

Texas has no state personal income tax, so for most Texas individuals the exchange is about deferring federal capital gains tax and depreciation recapture.

The two deadlines that control everything

Both clocks start the day your sale closes, and neither is extended for weekends or holidays.

• Day 45: you must identify potential replacement properties in writing, delivered to your qualified intermediary.
• Day 180: you must close on the replacement property. (If your tax return for the year of sale is due earlier, including extensions, that earlier date can apply. Your CPA should confirm.)

Forty-five days goes quickly. Touring, underwriting and negotiating a commercial property often takes longer than that, which is why experienced exchangers start their search before they sell.

Identification rules

When you identify replacement property, you generally follow one of these rules:

• Three-property rule: identify up to three properties of any value.
• 200% rule: identify any number of properties as long as their combined value doesn't exceed 200% of the property you sold.
• 95% rule: identify more than that, but you must then acquire at least 95% of the total value identified (rarely practical).

Most investors use the three-property rule: a first choice and two backups in case a deal falls through during due diligence.

Intermediary vs. broker: who does what

A qualified intermediary (QI) holds your sale proceeds so you never take possession of them, prepares the exchange documents and receives your identification notice. The QI must be engaged before your sale closes. If the money reaches you, the exchange fails.

Your broker's job is different: finding, evaluating and negotiating the replacement property, and coordinating the timing of the sale and the purchase so the deadlines are met. Your CPA advises on the tax outcome. A good exchange needs all three working together.

How much do you need to reinvest?

To defer all of the tax, the general rule is to buy replacement property of equal or greater value and reinvest all of the net proceeds. Cash you keep, or a reduction in debt that isn't offset, is called “boot” and is generally taxable. Ask your CPA to run the numbers before you set a purchase target.

Finding replacement property in Dallas-Fort Worth

Dallas-Fort Worth is a frequent destination for exchange money, especially for multifamily. That popularity cuts both ways: good properties attract competition, and an exchange buyer racing a deadline has less negotiating room than a buyer who can walk away.

A few practices make the difference:

1. 1

   Start the search when you decide to sell, not when you close. Tour and underwrite candidates while your property is being marketed.

2. 2

   Underwrite like a lender. Model property taxes after reassessment and current insurance costs, not the seller's numbers.

3. 3

   Identify real backups. Your two alternates should be properties you would actually buy, not placeholders.

4. 4

   Look at off-market options. Properties that aren't broadly marketed can mean less competition and more predictable timing.

5. 5

   Line up financing early if you're replacing debt.

Common reasons exchanges fail

• No qualified intermediary engaged before closing
• Sale proceeds paid to the seller instead of the QI
• Replacement property identified late or not in writing
• The identified properties fall through and there are no real backups
• Buying for less than needed and receiving taxable boot by accident
• Buying from a related party without understanding the special rules

Why investors work with JMD Signature Real Estate Group

Ownership disclosure: In the two projects listed below, Meetu Bhatnagar was the owner-operator (principal), not the broker. They are presented as her ownership and development experience, not as brokerage transactions by JMD Signature Real Estate Group.

JMD Signature Real Estate Group is built around Principal-Level Real Estate Representation™: advice from someone who has owned, developed and sold multifamily property.

Meetu Bhatnagar, Ph.D., CCIM, is a CCIM designee and licensed Texas real estate broker whose experience as an owner-operator includes:

• 418 units in Fort Worth: $37.5M acquisition, $54.5M disposition, ~2.5-year hold.
• A 306 unit luxury Class A multifamily development from acquisition of 11.5 acres of raw land; ~$54M project.

Historical results, not a guarantee of future outcomes.

See more on the track record page: jmdcre.com/track-record

Frequently asked questions

Planning an exchange? Start the search for your DFW replacement property before your sale closes.

Selling first? Read: How to Sell an Apartment Building in Dallas-Fort Worth (jmdcre.com/sell-apartment-building-dfw)

JMD Signature Real Estate Group | Meetu Bhatnagar, Ph.D., CCIM

Broker of record: RE/MAX DFW Associates

Disclosure: This guide is general information only and is not tax, legal or investment advice. Every exchange depends on your individual circumstances. Check with your CPA before making any decision, and work with a qualified intermediary on your exchange.