1031 Exchange Rules for U.S. and Foreign Real Estate

A 1031 exchange is a U.S. tax provision that allows businesses to “transfer” properties without requiring a sale and purchase agreement. The less legal jargony term for this is called the like-kind exchange. Utilizing this exchange allows you to defer capital gains taxes that you would typically pay out on a sale. You can then reinvest the proceeds into another property of equal or greater value. This strategy is often used by investors and business owners who want to keep growing their property portfolio without being hit with taxes at every sale.

How it Works in the U.S.

The majority of 1031 exchanges happen within the United States. As any other tax provision, there are rules, requirements, and additional pieces of information to know.

• Like-kind property: The replacement property must be for investment or business real estate.
• 45-day rule: After you sell your property, you have 45 days to find a replacement.
• 180-day rule: You must close on the new property within 180 days of the initial sale.
• Qualified intermediary: The funds from the sale are not allowed to touch your hands. You’re required to hire a QI to handle the proceeds and then transfer them to you once you find your replacement property.

This process lets investors continually roll their gains forward, deferring taxes and reinvesting more capital into larger or better performing properties.

How it Works with Foreign Properties

While less common, the 1031 exchange can also be used with foreign property. The IRS allows you (a U.S. citizen) to exchange foreign investment property for other foreign investment property. The same rules apply that it must be used for business or investment purposes. In addition to rules for transfering U.S. property, there are a few more to consider abroad:

• Like-kind requirement, 45-day rule, and 180-day rule
• Currency conversions: All reporting is in U.S. dollars, which can cause a gain or loss if exchange rates shift
• Local laws and taxes: Depending on which companies you are exchanging property from, there may be specific standards.
• Extra reporting requirements: You’ll be required to report any foreign bank accounts with FBAR and FATCA if they were used in the process.

Because of the challenges being foreign, finding a qualified intermediary who has experience in cross-border transactions is crucial.

Basic Overview

Here’s a sample breakdown of how the process looks:

1. Hire a qualified intermediary (QI): You’ll need to hire one before you conduct the closing. If it’s foreign business, ensure they have experience with that kind of transfer. 
2. Fill out the required forms: Form 8824
3. Sell your property: Woo! You sold your property, and now proceeds will go to your QI until you find another property.
4. Identify replacement property within 45 days: As mentioned before, you have 45 days to find a replacement property to conduct your business at. You can list up to three properties, or more under certain rules. 
5. Close within 180 days: Finalize the purchase of your replacement property with the funds from your QI.
6. Work with professionals: Coordinate with tax advisors, real estate attorneys, and local professionals (especially if it’s foreign) to complete the transaction.

Why U.S. and Foreign Property Don’t Mix

There is one limitation to be aware of — you can’t exchange U.S. property for foreign, or vice versa. The IRS does not consider them a like-kind. For example, selling an apartment in New York and buying one in Paris will trigger a taxable sale in the U.S. – no 1031 deferral allowed. You’re required to sell and purchase properties within their typical metrics.

Use It To Your Advantage

A 1031 exchange can be a very beneficial tool for deferring taxes and growing your business. Not only does it cut out the lengthy steps of processing a sale and new purchase, but it adds a middle man to take care of the specifics for you. Whether you’re using it within the U.S. or abroad, they work alike. However, if you’re looking to shift property from the U.S. to another country, consult with tax and real estate professionals to make sure everything gets completely according to country regulations