How does a 1031 exchange work when you sell a Colorado Springs rental?

A 1031 exchange lets you sell a rental or other investment property and buy another one while deferring the capital gains tax. You hire a qualified intermediary before closing, the sale money goes to them instead of to you, and then you have 45 days to identify the replacement property and 180 days to close on it. To defer all of the tax, you generally reinvest all of the proceeds and buy at least as much property as you sold. The tax is deferred, not avoided, so talk with a CPA before you list.

How a 1031 exchange works, step by step

1. Decide before you sell. The exchange has to be set up before your sale closes. Talk with your CPA and choose a qualified intermediary first.
2. Sell the rental. From the buyer's side, it's a normal sale. At closing, the proceeds go to the qualified intermediary, not to you.
3. Identify the replacement within 45 days. You have 45 days after the sale to identify the replacement property in writing.
4. Close within 180 days. You must close on the replacement within 180 days of the sale, or by the due date of your tax return for that year, including extensions, if that comes first. The two clocks run at the same time; the 45 days don't extend the 180.
5. Report it. The exchange is reported to the IRS on Form 8824 with your tax return.

What it was like when we went through it

We've personally gone through 1031 exchanges with our own rentals, and the process was easier than people expect. We hired a third party to hold the money, and it never landed in our bank account. That's the critical piece. The sale itself was a normal sale. When we bought the next property, we knew exactly how much was sitting with the intermediary, and that's what went toward the purchase.

One of those exchanges came out of a rental that wasn't paid off. It was an equity play: we built equity in it over time, sold it, and exchanged into the next property.

What counts as like-kind property

Since 2018, only real estate qualifies for a 1031 exchange. The property you sell and the one you buy must both be held for investment or for use in a business. Within that rule, "like-kind" is broad:

• a single-family rental for a duplex, a small apartment building, or a condo;
• a rental house for land or a commercial building;
• a Colorado Springs rental for an investment property in another state.

What doesn't qualify: property outside the United States, a home you buy to live in right away, and property you're holding mainly to fix and resell.

Delaware Statutory Trusts

Some owners exchange into a Delaware Statutory Trust (DST), a way to own a fractional share of a larger, professionally managed property. It can appeal to someone who wants to stay invested in real estate without being a landlord. A DST is an investment product with its own fees and limits on when you can get out, so review it with your CPA and a financial advisor.

Boot: the part that's taxed

"Boot" is anything you receive in the exchange that isn't like-kind property. It's taxable. The two most common kinds:

• Cash you take out. If you keep some of the proceeds instead of reinvesting them, that amount is taxed.
• Debt you don't replace. If the mortgage on the new property is smaller than the one you paid off, and you don't make up the difference with additional cash, the difference is generally treated as boot.

That's why a full deferral generally means buying a property of equal or greater value and putting all of the proceeds into it. Your CPA can run the numbers for your sale.

If the rental used to be your home

Many Colorado Springs rentals started as someone's home. A former residence can qualify for an exchange once it's held as a rental. The IRS has a safe harbor for homes: owning the home for the 24 months before the exchange, renting it at a fair rent for at least 14 days in each of those two years, and keeping personal use within set limits.

If you still meet the 2-of-5-year test for the home-sale exclusion, compare that with an exchange before you decide. How capital gains work when you sell a Colorado Springs home explains the exclusion.

Can you move into the replacement property later?

Possibly. You can buy a replacement property, rent it out, and eventually move in. But it has to be held as an investment first, and the same IRS safe harbor applies to the 24 months after the exchange. If you later sell it as your home, you must have owned it at least five years after the exchange before its sale can use the home-sale exclusion, and the exclusion may be limited. Plan this with your CPA before you buy.

Deferred, not avoided

A 1031 exchange postpones the tax; it doesn't erase it. The deferred gain carries into the new property, and it comes due when you eventually sell without exchanging again. Some owners exchange more than once over the years. Either way, the decision should fit your larger goals, which is why I start with the Life → Wealth → Real Estate™ conversation: your life goal first, then how to make the most of it for your wealth, then the property.

What's specific to a 1031 exchange on a Colorado Springs rental

• Out-of-state owners and Colorado withholding. If you don't live in Colorado, the title company generally withholds the lesser of 2% of the sale price or your net proceeds on sales over $100,000. The Colorado Department of Revenue's form doesn't address exchanges specifically, so ask your title company, qualified intermediary, and CPA early how withholding will be handled on your sale.
• Timing the tenant's move-out. If the home needs to be vacant to sell, Colorado's notice rules for ending a tenancy can add months before you can list, and the 45-day clock starts only when the sale closes. When to sell a Colorado Springs rental covers lining up the move-out with the listing.
• Exchanging out of the area. The replacement can be anywhere in the United States. If you're buying somewhere other than Colorado Springs, I can help you find and personally vet a real estate professional in that market, which helps when the 45-day window is short.

How to plan the timing

What could change the answer

• Whether the property has been held as a rental or investment, especially if it was once your home.
• Whether you reinvest all the proceeds and replace the debt, or take some cash out.
• Whether you can identify and close on a replacement within the deadlines.
• Your residency and tax situation, including Colorado withholding.
• Your goals: staying invested, simplifying with a DST, or selling outright.

When to talk with a professional

Talk with a CPA before you list, about whether an exchange fits and what you'd owe with and without one. Choose a qualified intermediary before your sale closes, and ask how they hold and protect the funds. Talk with a financial advisor before investing in a DST. Have a real estate attorney review anything unusual, such as related-party sales or a reverse exchange, where you buy before you sell. And bring your real estate professional in early, so the sale and the purchase are planned together.

Sources

• IRS, Like-Kind Exchanges: Real Estate Tax Tips: https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-tips
• IRS, Instructions for Form 8824: https://www.irs.gov/instructions/i8824
• IRS Revenue Procedure 2008-16 (safe harbor for dwelling units): https://www.irs.gov/pub/irs-drop/rp-08-16.pdf
• IRS Revenue Ruling 2004-86 (Delaware statutory trusts): https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
• 26 U.S.C. § 121(d)(10), property acquired in a like-kind exchange: https://www.law.cornell.edu/uscode/text/26/121
• Colorado Department of Revenue, Form DR 1083 (Information with Respect to a Conveyance of a Colorado Real Property Interest): https://tax.colorado.gov/DR1083
• Colorado Revised Statutes § 39-22-604.5 (withholding on nonresident real property sales): https://colorado.public.law/statutes/crs_39-22-604.5