Unlocking the power of 1031 exchanges can potentially enhance your investment returns. But with specialized terminology and intricate rules, it’s easy to get lost in the details. I’m here to help demystify the 1031 exchange by defining the top six key terms every investor should be familiar with. Gain a deeper understanding of this valuable tax strategy, so you confidently navigate this tax-deferred real estate transaction.
1. Relinquished Property
The relinquished property in a 1031 exchange refers to the investment property you sell to trigger the exchange. This can encompass various asset classes, including rental properties, commercial buildings, land and even certain types of business property. It’s important to note the relinquished property must be held for investment purposes and not for personal use.
2. Replacement Property
The replacement property is the investment property you purchase with the proceeds from the sale of your relinquished property. To qualify for a 1031 exchange, the replacement property must be “like-kind,” meaning it must also be an investment property and used for business rental purposes. You have the flexibility to purchase multiple replacement properties as long as the combined value of these properties is equal to or greater than the value of the relinquished property. I have an expansive list of these types of properties available that you can register to look through.
3. Qualified Intermediary (QI)
The qualified intermediary (QI) is a neutral third party that specializes in 1031 exchanges and acts as a middleman in the exchange. The QI receives the proceeds from the sale of your relinquished property and holds them during the exchange process. They then facilitate the purchase of your replacement property according to your instructions. Using a QI is essential for a successful 1031 exchange because it ensures the IRS views the transaction as a legitimate exchange and not a taxable event. A QI may also be referred to as a facilitator. We are happy to provide referrals.
4. Identification Period
The identification period is a critical step in a 1031 exchange. You have a strict 45-day window after selling and/or closing your relinquished property to identify potential replacement properties to your qualified intermediary. During this time, it’s critical to follow three rules – more on that here. You can specify up to three properties or identify several properties using alternative identification rules such as the 200% or 95% rule. Missing the identification deadline can disqualify your exchange.
5. Closing Period
The closing period provides a 180-day window from the sale of your relinquished property to acquire the replacement property. Given this relatively short timeframe, it’s crucial to have a well-defined plan and collaborate closely with your qualified intermediary to ensure the exchange is completed within the deadline.
6. Boot
“Boot” refers to any portion of a 1031 exchange that isn’t eligible for tax deferral. Common types of boot include cash received from the sale, mortgage relief (if you assume a smaller mortgage on the replacement property) and the difference in value between the relinquished property and the replacement property if the replacement property is worth less. Boot is subject to immediate taxation.
Great job learning these key 1031 exchange terms! You’ve taken a crucial step toward mastering 1031 exchanges. Since each investor’s path is different, please reach out to me for a complimentary consultation, to explore how 1031 exchanges can potentially help you achieve your real estate and investment objectives. For an expansive list of definitions, you can visit the glossary here.
Diversified Investment Strategies is a team of seasoned professionals specializing in 1031 tax-deferred exchange solutions, offering customized strategies and expert analysis to identify potentially suitable investments, including DSTs, UPREITs, opportunity zones, TICs, NNN properties and oil & gas royalties. With a proven track record of hundreds of successful exchanges, we empower our clients to make informed investment decisions. Contact us at www.diversified1031.com or 949-379-2080.
*Example portfolio is hypothetical and for illustrative purposes only. Individual results will vary and are not guaranteed. Because investor situations and objectives vary this information is not intended to indicate that an investment is appropriate for or is being recommended to any individual investor. This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section. DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65). Individuals holding a Series 66 do not fall under this definition) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Diversified 1031 is independent of CIS. FOR ACCREDITED INVESTOR USE ONLY.