1031 Exchanges Q & A’s

A Qualified Intermediary is necessary to create the exchange of properties required under Section 1031. A Qualified Intermediary simplifies the exchange process by accepting a transfer of your property, conveying it to the buyer, taking custody of the proceeds, buying the replacement property and transferring ownership to you.

Qualified Intermediaries are appointed only to carry out the exchange and prepare the necessary documentation for tax-deferral. They are not allowed to counsel you on the desirability or tax implications of an exchange.

A replacement property must be submitted in writing, clearly described and signed by you and must be delivered or sent before midnight of the 45th day from the date of the transfer of your relinquished property.

If you transfer the relinquished property and do not replace it with another, the sale will create a taxable event, so any capital gains will be subject to federal and state taxes. If you are not sure, we suggest on the side of caution and provide the money to an Accommodator to give you extra time to decide.

If you actually or constructively received proceeds from the sale, it may not be possible to include that property in a tax-deferred exchange. That’s why it’s important to note your intention to make this transaction a part of a tax-deferred exchange in the sales contract. If you have entered into a contract to sell, but have not closed, it may be possible to carry out a deferred exchange. At this point you can choose to do a full or partial exchange provided you execute the proper exchange documents, identify the replacement property within 45 days of the closing and actually receive it within 180 days or before your tax return is due. Your attorney or tax advisor can help you make this determination.

No, your personal residence is not considered property held “for productive use in a trade or business” or “for investment,” so does not meet the requirements of Section 1031. Internal Revenue Code Section 121 allows an individual to exclude from taxation up to $250,000 of the capital gains realized on the sale of an individual’s principal residence. Married couples filing jointly can exclude up to $500,000.

No, you do not. You will, however, be taxed on the amount you don’t spend. Unused proceeds are known as boot and are taxed on their face value at the capital gains tax rate. (See Partial Exchange)

You can receive unused proceeds any time after you have acquired each one of the properties identified within your 45-day identification. If you do not acquire all the properties identified within the 45-day identification, then the unused proceeds cannot be released until the due date of your tax return, including extensions or 180 days after the closing of the sale of the relinquished (exchanged) property.

Yes, you can combine multiple relinquished properties into one replacement property. The rule here is the first relinquished property to close starts the clock for all the rest. All the relinquished properties to be combined must be closed within 45 days of the first one to close. The same replacement property is then identified for each relinquished property to be combined.

The IRS requires you to show intent to use the replacement property as a rental. Most tax attorneys believe a property listed as a rental on two or more consecutive tax returns is considered intent.

Capital gains tax is calculated the same way as in any other sale, assuming you have not converted it to residential use and you are not going to do another 1031 Exchange. The key is to establish the basis on the new property at the time of sale. The basis on the new property is the sum of the basis transferred from the old property, plus the difference between the sale price of the relinquished property and the new replacement property, minus the depreciation on the new replacement property.

The best way to confirm if you have an exchange is to ask the principals involved. Is the property my residence? If yes, then the you will not be eligible for a 1031 Exchange. Does the buyer intend to live at the property? If yes, then the buyer will not be eligible for a 1031 Exchange. Is the property intended for investment purposes? If yes, then either the seller or buyer may want to perform a 1031 Exchange.

In today’s real estate market, it is imperative real estate brokers and agents understand the options a 1031 Exchange can offer their clients. Without such knowledge, brokers and their agents are open to potential liabilities. Unfortunately, brokers can be as liable for what they don’t say, as well as for what they do. Simply offering the option of a tax-deferred exchange can eliminate potential liability on the broker’s part.

The simple answer is almost any type of investment real estate you want. The IRS generally considers all investment properties to be like-kind. Utilizing tools such as a DST, TIC, UPREIT, etc., raw land can be exchanged for an office building, a strip mall can be exchanged for an industrial building or a rental home exchanged for one or more fractional 1031 properties.

The most important reason is to defer potentially taxable gain realized from a sale of a property. You may be able to use all of your equity to acquire another property instead of the amount of equity remaining after paying applicable federal and state income taxes on your gain. Additionally, the ability to go from one type of property to another allows you to utilize other concepts such as leverage, diversification, cash flow, consolidation, management relief and, possibly, increase your depreciation.

It is applicable when the property in question falls within the like-kind definition, you intend to buy another property of like-kind within 180 calendar days following the close of escrow from the sale and when you have a recognizable gain.

After an exchange has been arranged and you have contacted a Qualified Intermediary prior to closing a sale, you must identify up to three potential properties you may intend to acquire within 45 days of the close of the sale escrow. You can list or identify four or more properties; these properties, however, cannot have an aggregate value of 200% or more of the sale of the relinquished property. If more than three properties are identified, and the value exceeds 200% of the sale price, then you must close escrow on 95% of the list. Escrow must close on at least one of the identified properties within 180 calendar days from the date of the close of the sale escrow. The three rules:

1. The Three Property Rule: Three replacement properties of any individual or combined value. One or more of the three named properties can then be purchased as qualifying replacement property.
2. The 200% Rule: Name as many properties as desired as long as the total value of all properties does not exceed 200% of the sales price of the relinquished property.
3. The 95% Rule: Name as many properties as desired regardless of total value (even exceeding the 200% Rule described above), as long as the investor ultimately buys as their replacement property at least 95% of the total value of all properties named under this method.

In the first phase of the exchange, it is imperative you do not receive any money. The net proceeds must be wired to the Qualified Intermediary into a separate, interest-bearing account. Since each exchange has its own account, you must call the Qualified Intermediary prior to wiring to obtain the account number. If not, the wire will probably be returned to you due to insufficient information. In the second phase of the exchange, the funds required to close the transaction will be sent to you from the exchange account held by the Qualified Intermediary. You will need to contact the Qualified Intermediary to find out exactly how much money is in the exchange account. In the event there are insufficient funds in the exchange account to close your escrow, you will have to deposit the additional funds required to close the escrow.

There is nothing different in how the exchange is handled, but the Qualified Intermediary will need to see a copy of the trust agreement, the partnership agreement or a corporate resolution.

To have a valid exchange, your vesting should be exactly the same in the second phase transaction as it is in the first phase. If you own the relinquished property in your personal name, you should not put the replacement property into a family trust until after the exchange is closed.

No. For an exchange to be 100% tax deferred, you must acquire a replacement property that is of equal or greater value and spend all of the net proceeds from the relinquished property.