Section 1031 Tax-Deferred Exchange Q+A
When should you consider a 1031 Exchange?
Great question! When the proceeds from the sale of real property or personal property are used to purchase other like-kind property, you should consider a Tax-Deferred Exchange. The IRS recognizes the use of an Accommodator or Qualified Intermediary as a safe harbor for your transaction. The sale and purchase of property held for use in a trade or business or for investment purposes can be done as a delayed exchange, reverse exchange or a simultaneous exchange. All three qualify for tax-deferred treatment.
There are important guidelines and tricky pitfalls you need to be aware of if you want total tax-deferment. We recommend Pioneer 1031 Company; they can help you set up a 1031 Tax-Deferred Exchange as well as explain the steps for your particular exchange. Although they cannot give specific tax advice, they do give consultations free of charge.
What is a Qualified Intermediary?
A qualified intermediary is required by the IRS to remain an independent third party to your exchange transaction.
We do suggest you always consult your attorney and tax advisor for specific details regarding your financial situation. Then contact a qualified intermediary to handle your exchange transaction.
What is Like-Kind Real Property
Like-Kind Requirement: Replacement property acquired in an exchange must be “like-kind” to the property being sold (relinquished property). Like-kind means “similar in nature or character, notwithstanding differences in grade or quality.” In order for the properties to qualify as “like-kind,” they must be held for productive use in a trade or business or held for investment purposes and be located within the United States. Foreign property does not qualify.
For example: raw land held for investment may be exchanged for single family rentals or any combination of the below examples:
- Single Family Rentals
- Farms/Ranches
- Offices
- Motels/Hotels
- Golf Courses
- Multi Family Rentals
- Raw Land
- Retail
- Industrial
- Leases of 30 years or more
Property not eligible under 1031…
- Primary Residence
- Interest in Partnerships
- Foreign Property
- Money
- Stocks, Bonds, or Notes
- Stock in trade, inventory or other property held inherently for sale
Section 1031 of the Internal Revenue Code, Sec. 1031 [1986 Code] 1031 – Exchange of property held for productive use or investment (a) Non-recognition of Gain or Loss from Exchanges Solely in Kind.
(1) IN GENERAL – No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.
(2) EXCEPTION – This subsection shall not apply to any exchange of a stock in trade or other property held primarily for sale.
- stocks, bonds, or notes
- other securities or evidences of indebtedness or interest
- interest in a partnership
- certificates of trust or beneficial interests, or
- closes in action.
(3) EXCHANGES OF LIVESTOCK OF DIFFERENT SEXES – for purposes of this section, livestock of different sexes are not property of a like-kind.
Timeframes
To do an Exchange, you need to keep in mind there are two very important time restrictions: the 45-day identification period and the 180-day exchange period. When you violate one of these time periods, your exchange fails. These time restrictions are carved in stone. The only exception is in the event of a natural disaster and the federal government issues an extension.
Your total exchange period is 180 days from the date the warranty deed recorded on your relinquished property(ies) in a delayed exchange or on your replacement property(ies) in a Reverse Exchange, when the EAT is taking title. To complete your exchange, you must have a recorded warranty deed to complete your exchange before midnight of the 180th day. In some cases, you will need to file for an extension for filing your income tax return in order to receive the entire 180 days in a delayed exchange. From the date of recording of the Warranty Deed on your initial property(ies), the 45-day identification period begins.
From that time, you have only 45 days to identify in writing to your Accommodator, the property or properties you wish to purchase, or sell, to complete your exchange. The trick is complying with the strict rules in completing your identification notice. Your accommodator (Intermediary), can instruct and help you comply with those rules.
IRS Guidelines
1. Equal or Greater Property Value
Replacement property fair market value must be equal to or greater than the fair market value of the relinquished property. If you wish to acquire property of less value, you may. But please speak with your tax advisor regarding possible tax consequences.
2. Use All Proceeds From the Sale
You must use all of your exchange proceeds from the sale of the relinquished property to acquire your replacement property. If you would like to receive cash for personal use, you must make arrangements prior to the disbursement of sale proceeds by the escrow closer. Under the exchange regulations, you may not have the ability to control or direct funds in any way once proceeds have been sent to the exchange facilitator. Remember, you should only use exchange proceeds to acquire real property. Speak with your tax advisor regarding possible tax consequences of taking exchange funds for personal use.
3. Equal or Greater Debt
Your replacement property debt (mortgage) must be equal to or greater than your relinquished property debt (mortgage). You may acquire less or no debt on your replacement property, but you should speak with your tax advisor regarding possible tax consequences of “debt relief.” The guidelines listed above are to be used to help you effectuate a Tax-Deferred Exchange. If you don’t meet all the guidelines, you may still do an exchange, but you may be subject to tax on the difference. The IRS has defined several black and white areas, but there are many more gray areas, which are difficult to elaborate on without details about your specific tax situation. It is highly recommend you seek specific tax advise from your tax advisor or attorney, particularly when attempting a partial exchange.
Using the below Capital Gains Calculator may help you determine if an exchange would be of benefit to you.
Capital Gains Calculator
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