1031 EXCHANGE NOTE: The following questions and answers are intended to provide basic information for our clients. Each client has different taxable transactions and it is strongly recommended that you have all questions reviewed by the Exchange Accommodator and your legal counsel.
What are the costs involved in a 1031 Exchange? The exchange fee for property under $200k (1 for 1) is $600, with no interest paid to the exchangor. For exchange property in excess of $200k, the exchangor has a choice of two fee options. If the exchangor chooses to earn interest on exchange funds held, the fee is $750 plus $250 for each replacement property. If the exchangor chooses not to receive interest, the exchange fee is $500 plus $250 for each replacement property. Please call us for quotes on reverse and construction exchanges.
When is it to late to perform a 1031 Exchange? The decision to exchange must be made prior to closing of the relinquished property. The exchange agreement must be in place and delivered to all parties before the relinquished property transfer of title.
What is the Basis in the Replacement Property? In an exchange, the deferral of the tax on the gain is accomplished by requiring the taxpayer to carryover (substitute) the basis of the relinquished property to the replacement property with appropriate adjustments in the event additional consideration is paid.
Can the proceeds from the sale of the relinquished ( sold) property simply be held in escrow at closing? The proceeds from the sale of the relinquished property should be delivered to a “qualified intermediary”. The proceeds cannot be held in escrow, unless the escrow account in question is either a “qualified escrow account” or a “qualified trust account” and not subject to the control of the investor. Any control by the investor isconsidered to be constructive receipt and is boot.
Explanation of the 45-day Identification Period and when it begins. Section 1031 requires that the replacement property be identified within 45 days of closing on the relinquished property. This identification period is strictly enforced and violation will defeat the tax deferral.
Explanation of the 180-day exchange period and when it begins. Section 1031 requires the replacement property be purchased within 180 days of closing on the relinquished property OR the date the taxpayer’s tax return is due, whichever date is first. The purchase date is considered to be the closing date. Note that for tax return due dates that fall before the 180 days, a tax return extension can be filed. However, a taxpayer can never amend their return for extension purposes.
Can I hold a mortgage on my relinquished property and still have an exchange performed? Yes, the mortgage payment received is considered an installment sale and is subject to taxation as deemed received. The balance of the taxpayer’s equity can be used as a deferred exchange.
Is there an extension allowed to either the 45-day period or the 180 period? The IRS does not allow extensions for either the 45-day period or the 180-day period. If you fail to identify property within the 45 days or close prior to or on the 180 day you will have not satisfied the requirements for an exchange thereby exposing your sale to capital gains taxes. If a taxpayer executing an exchange does not acquire a replacement property and the exchange period straddles two tax years, the transaction becomes an installment sale and is taxable in the subsequent year.
If the exchangor’s 45th or 180th day falls on a weekend or holiday do I get the benefit of the following business day? No. The IRS calculates this timeline based on calendar days. There are no extensions given.
When is a 1031 exchange considered completed? A 1031 exchange is considered complete once the exchangor has acquired title to all of the identified replacement property(s) to which the exchangor is entitled, within 180 days.
What does the term “Boot” mean? In an exchange of real property, any consideration received other than real property is “boot.” The amount of gain recognized is always limited to the gain realized or boot, whichever is the smaller amount. Therefore, for a transaction to result in no recognized gain, the taxpayer must receive property with an equal or greater market value and debt than the property relinquished, and receive no boot. In exchanges, there are two types of boot: cash boot and mortgage boot. Cash boot is cash or anything else of value received. Mortgage boot is any liabilities assumed or taken subject to in the exchange.
What does Trading up mean? It is adding money to an exchange and acquiring an even more expensive piece of property than you sold. Or, you can increase your debt, but you must use all of the proceeds from the relinquished property as well.
Does vacant land qualify as like-kind property? Yes, vacant land is like kind with all other types of real property. However, like other properties, in order to qualify for a 1031 Exchange, the land must be held for productive use in a trade or business or for investment.
If the relinquished (sold) property is classified as residential income property, does the replacement property need to be residential income property? No. The like-kind requirement does not limit the type of real property acquired in an exchange. You may exchange residential income property for commercial property, commercial property for industrial property and vacant land for residential income property. Any combination of properties may be exchanged. Again, any property involved in an exchange must be held for productive use in a trade or business or for investment.
What are the requirements for deferring tax on capital gains? In order to defer all of the tax on the sale of investment property, first make sure that the relinquished and replacement properties are “like kind” and held for productive use in a trade or business or for investment. Second, make sure that the timelines for the exchange are met. Third, make sure that all of the proceeds generated by the sale of the relinquished property are used in the purchase of the replacement property and that the FMV of the replacement property is equal to or greater than sale price of the relinquished property. If any of the first two requirements listed are not met, no exchange is possible. If any of the third requirement is not met, a taxpayer may be able to partially defer their gain but not wholly.
Am I required to have a mortgage on the replacement property? No. To avoid mortgage boot on the net debt relief, the replacement property financing should include debt equal to or greater than the debt on the relinquished property. If the investor wishes to reduce their overall debt, they may contribute cash out of pocket to the purchase of the replacement property. Cash contributions by the investor serve to offset net debt relief.
I have identified my Replacement Property but have not sold my investment property. Can I still do a 1031 exchange? Yes. Reverse exchanges are recognized by the IRS and can be accomplished by the intermediary acquiring title to one of the exchange properties. Reverse exchanges are often complex transactions. Please feel free to contact us to discuss the issue in more depth.
I’ve already sold my property. Can a 1031 Exchange still be performed? Yes, provided your sale has not closed yet, simply contact us and we will turn your taxable sale into a tax free exchange with some simple paperwork. You can call us right up until the day before closing.
Do I need to amend my sale and purchase contracts when conducting a 1031 Exchange? Does my Realtor need to mention the 1031 Exchange on the MLS listing of my property? No. Tax law does not require amending sales or purchase contracts nor does it require amending MLS property listings.
However, in order to complete an exchange, both parties to the sales and purchase contract must agree to an assignment of contract rights from the exchanging party to the qualified intermediary. Although the assignment of rights does NOT effect the party not involved in the exchange, both parties still must agree to the assignment of contract rights from exchangor to intermediary. In order to prevent any surprises at closing, it is probably wise to insert language into the sales and purchase contracts that stipulate the transaction involves an exchange. Inserting language into the MLS listing does not create a contractual obligation and therefore does not add any security to the exchange.
Can I build on property I already own? Not with deferred tax dollars.
Can I use a Build to Suit Exchange as a replacement property? Yes, but you must take title within 180 days.
Can I buy more than one piece of property tax free? Yes, you can acquire any number of replacement properties. However, you are require to buy all the properties you have identified if the number of properties exceeds three (3).
How will this affect my Estate Planning? If you hold the exchanged property until death, your heirs receive a stepped up basis to fair market value, and the capital gain is never taxed, which means the income taxes that were deferred by you now become permanently tax-free to your heirs.
If I want to use a 1031 Exchange, but my co-owner wants to cash out and take his money, is that allowed? Yes, however, his portion will be subjected to the tax on any profit/gain. Partnership interests cannot be used as exchanges.
Can I exchange my property for a property in another state? Yes. You may invest tax deferred capital anywhere in the country. Frequently, out of state investment can be very attractive investment.