What is a 1031 Exchange?
A 1031 Exchange is a transaction permitted under the tax code whereby an Exchangor can exchange (sell and purchase) one business or investment property for a like-kind property of equal or greater value, without realizing the tax consequences. Although 1031 Exchanges apply to personal property, real property cannot be exchanged for personal property.
WHAT DOES LIKE-KIND MEAN?
Like-kind means a Replacement Property that is also held for business or investment purposes. You can exchange a single unit rental for a multiunit building, or an office building for raw land or a vacation rental. The focus is the nature or character of the property. Like kind also requires a U.S. property to be exchanged for another U.S. property.
What does equal or greater value mean?
This means that if you sell your property for $1MM, even if there is only $200,000 of equity and an $800,000 mortgage on the property, you must purchase a Replacement Property that costs at least $1MM. You will either be required to take out a new mortgage or pay cash to make up the difference.
Does my property qualify for a 1031 exchange?
If your property was used for business or investment purposes, it will generally qualify. A personal residence or vacation property used primarily for personal use does not qualify. A personal residence can be converted to an investment property but this takes significant advance planning and consultation with a tax professional.
What are the timeframes for completing a 1031 Exchange?
There are two crucial time periods for completing a deferred 1031 exchange- 45 days and 180 days. Both time period begins on the date the Relinquished Property closes escrow. The Exchangor has 45 days to identify the Replacement property and 180 days to close escrow. There are virtually no exceptions to these time periods.
How many properties can I identify?
There are three applicable Identification rules: the 3 Property Rule, the 200% rule, and the 95% rule (this rule is very difficult to satisfy and thus not recommended).
The 3 Property rule permits the Exchangor to identify up to three properties regardless off the Fair Market Value of the properties.
The 200% rule permits the Exchangor to identify four or more properties, so long as the total Fair Market Value at the end of the identification period does not exceed 200% of the value of the Relinquished Property.
What if I don’t invest 100% of the funds received on sale of the Relinquished Property?
If you wish to take cash from the sale, that can be done, but any cash received by the Exchangor will be taxable in the year it is received. If the remainder of the transaction qualifies under the 1031 regulations, the remainder of the funds will receive tax deferral. You must let your Exchange Accommodator and escrow know as soon as possible if you intend to receive cash. Once the funds are transferred from escrow to the Exchange Accommodator, the Exchange Accommodator will not be able to distribute cash to you.
How long do I have to hold property before I can do a 1031 Exchange?
There is no clear rule on this. The I.R.S. will look at the Exchangor’s intent. If it appears the intent was to flip the property, the exchange will fail. A 1-2 year holding period is generally recommended but facts and circumstances affect this determination. For example, if a property was purchased with the intent to serve as a vacation rental, but after eight months the property has been unsuccessful in producing income and the Exchangor can show evidence of this such as hiring a property manager, advertising the property, etc., a shorter period may be permitted. You should consult with a tax professional regarding your specific facts and circumstances.
What about the incidental property involved in the purchase of real property?
Property that is typically transferred together with the larger item of real property will be treated as incidental and disregarded where the aggregate fair market value of the incidental property does not exceed 15% of the aggregate fair market value of the real property. For example, an apartment complex will include incidental property such as washer and dryers, dishwashers, refrigerators, etc.
WHY SHOULD I USE A Qualified Intermediary/Exchange Accommodator?
An Exchange Accommodator is experienced in facilitating 1031 Exchanges. There are some alternative means of achieving a 1031 Exchange but use of an Exchange Accommodator is common because the rules are very technical. In California and some states, Exchange Accommodators are required to be licensed and bonded. We are happy to provide our clients with a copy of our current bond and insurance.
What property is excluded from 1031 exchanges?
The following property is excluded from 1031 Exchanges: Inventory or stock in trade; Stocks, bonds, or notes; Other securities or debt, Partnership interests, and Certificates of trust.
HOW DO I START THE PROCESS OF A 1031 EXCHANGE?
- Consult with your tax advisor to determine your capital gains tax.
- Notify your real estate agent and escrow officer that you will be conducting a 1031 Exchange.
- Contact Growth 1031 as soon as you accept an offer or make an offer on a potential exchange property.
- Forward your full name, contact information, property address.
- Forward the full name and contact Information of your escrow officer for the exchange property