Need 1031 Exchange Resources?>1031 Exchange FAQ

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What is a 1031 exchange?

In a usual transaction, the seller of a property is taxed on any gain from the sale. A 1031 exchange, however, allows tax on the gain to be deferred until a later date. According to 1031 of the Internal Revenue Code, no gain or loss is recognized on the exchange of property held for trade, business, or investment purposes.

A 1031 exchange typically involves an owner trading a relinquished property for a replacement property, provided that they are of "like-kind". This allows deferment of federal income taxes and some state taxes on any gain or loss from the transaction.

Bear in mind that a 1031 exchange is tax-deferred, not tax-free. At some future date when the replacement property is sold outside the safe-harbor of a tax-deferred exchange, tax must be paid on the original deferred gain, plus any additional gain realized since the purchase of the replacement property.

What are the benefits of doing a 1031 exchange versus just selling my property?

The biggest advantage of a 1031 exchange is that 1031 exchanges provide one of the only techniques for the postponement (or potential elimination) taxes due on the sale of qualifying properties. This deferment of tax provides an investor with more money available to invest in another property.

Other benefits include the postponement of any gain from depreciation recapture, and the ability to reallocate investments in a portfolio through the acquisition of disposition of properties without paying tax on gains.

What are the different types of exchanges?

Forward or Delayed Exchange

A delayed exchange is the most frequent type of exchange. Delayed exchanges occur when the transfer of the Relinquished Property happens previous to the acquisition of the Replacement Property. Treasury Regulations outline stern time limits on Delayed Exchanges.

Simultaneous Exchange

Simultaneous Exchanges occur when the relinquished property and replacement property are exchanged at the same time.

Reverse Exchange

Reverse exchanges consist of the acquisition of a replacement property prior to the transfer of the relinquished property. Reverse exchanges are also sometimes known as "parking arrangements".

Build-to-Suit Exchange

Sometimes referred to as improvement or construction exchanges, built-to-suit exchanges allow the taxpayer to use exchange proceeds towards construction on or improvements to the replacement property.

What are the criteria for an acceptable tax-deferred exchange?

Firstly, the property to be exchanged must be considered a Qualifying Property. In general, if regulations do not specifically exclude property from 1031 exchanges, they can qualify for tax deferment. There are however, certain specific exclusions including but not limited to: properties owned primarily for sale, bonds, notes and stock, inventories, stake in a partnership, and certificates of trusts or beneficial interest.

The relinquished property and replacement property must also meet the standard of being used for Proper Purpose. Properties must be owned for productive use in business, trade, for investment. For example, an exchanger’s home does not qualify.

The two properties to be exchanged must also be of Like-Kind. In the United States, all real property is considered to be of like-kind.  Foreign property, however, is not considered like-kind to property located in the United States.

Lastly, the transaction must be an exchange, meaning the relinquished property cannot be sold for cash and the replacement property purchased with the proceeds.

How can I make sure to defer the entirety of the taxable gain?

To ensure the deferment of your entire gain, the entirety of the proceeds from the sale of the relinquished property must be used to acquire the replacement property. Additionally, make sure that the value of, equity in and debt on the replacement property are equal or greater than the corresponding amount in the relinquished property.

When can I get my money back from RockSolid?

RockSolid keeps your money completely liquid, so you can get it out whenever you need it. Money given to RockSolid will only be invested in government-backed securities, giving you the highest level of security and liquidity. Bear in mind, however, that to ensure complete tax deferment of your gain, the taxpayer must not take delivery of any money until the exchange is complete. To receive a percentage of the proceeds in cash, it must be done before depositing funds with RockSolid, and the amount taken in cash will be subject to taxation.

Can the replacement property eventually used as my residence or a vacation home?

Yes. Experts recommend holding the replacement property for at least a year in a proper use capacity before changing its primary use. The IRS, however, does not have any specific regulations on this point.

Are second homes and vacation homes eligible for 1031 exchanges?

Until very recently, this question was one of the most widely disagreed upon by 1031 exchange experts. The IRS Revenue Procedure 2008-16 now provides guidelines for determining whether a second or vacation home qualifies as a business or investment property. For the full text of Revenue Procedure 2008-16 follow the below link: http://www.natptax.com/rp200816.pdf

Can I sell my relinquished property and use a separate bank account to hold the proceeds until acquiring the replacement property?

No. If the taxpayer takes receipt of the funds in any way they disqualify their transaction from potential tax deferment. A qualified intermediary such as RockSolid is a necessary third party who facilities the exchange by taking receipt of the proceeds from the sale of the relinquished property, holding them until they are needed for acquisition of the replacement property, and then when needed giving the funds to the closing agent. This process prevents the taxpayer from ever taking receipt of funds, and enables the tax-deferment as outlined in Section 1031.

If I’ve already signed a deal to sell my property, can I take advantage of a 1031 exchange?

If you have not yet transferred title or benefits and burdens of your property, you can still take advantage of a 1031 exchange. If the closing has occurred, even if you have not physically taken receipt of the funds from the transactions, then it is not possible to begin a 1031 exchange.

Will my Qualified Intermediary take title to the properties?

Typically no, and deeds are transferred as in a normal sale. Unlike a normal sale, however, in a 1031 exchange the qualified intermediary takes assignment of the exchanger’s interests and sale contracts.

What time limits are there on a 1031 exchange?

Following the sale of the relinquished property, an exchanger has 45 in which to identify potential replacement properties. Within 180 days of the sale of the relinquish property (or before filing the tax return for the year in which the relinquished property was sold), the acquisition of a replacement property must be completed. The IRS does not grant any extensions on time limits, except in some cases involving disaster areas.

What rules apply to the identification of possible replacement properties?

One of three of the following rules must be followed during the identification of replacement properties:

  • 3-Property Rule: Identify up to 3 potential replacement properties, without regard to their value
  • 200% Rule: Identify any number of properties so long as their total value does not exceed twice the value of the relinquished property
  • 95% Rule: Identify any number of properties, so long as by the end of the exchange period 95% of the aggregate fair market value of all the identified properties is acquired.

How do I properly identify a replacement property?

Identification of a replacement property must be done in writing and cannot be done orally. This written identification must then be delivered to a non-disqualified party. Family members or any agent of the taxpayer within the last 2 years are disqualified parties.

Can the proceeds from the relinquished property be used to make improvements to the replacement property?

Yes, although the taxpayer is not permitted to build on property she already owns. In what is called a Build-to-Suit, Construction or Improvement Exchange, an unrelated party must take title to the replacement property and make improvements before conveying title to the taxpayer before the end of the exchange period.

What is Boot?

Boot refers to any property that the taxpayer receives as part of the exchange which is not considered to be like-kind to the relinquished property. Boot can be either "cash" boot or "mortgage" boot.

What is the difference between realized gain and recognized gain?

Realized gain is defined as the economic gain resulting from selling as asset at a higher price than the original purchase price. Recognized gain is that which is taxable as capital gain. Recognized gain in a 1031 exchange is the realized gain or the net boot received, whichever is less.

What is Mortgage Boot?

Liabilities acquired or surrendered by the exchanger are considered mortgage boot. If upon the sale of the relinquished property, the owner is relieved of debt, the owner is considered to have received mortgage boot. This relief amount is taxable, unless it is offset by other boot in the transaction.

What is Cash Boot?

Cash Boot is any boot received by the taxpayer, excluding mortgage boot, and can take the form of cash or other property.

I closed on my first replacement property within 45 day identification period. Can I still identify three more properties within the identification period?

According to the three property rule, the completed acquisition counts as one identified property, allowing you to identify only up to two additional properties.

Still curious or have an interesting situation?

Call 646.695.4700 to learn more and speak with a RockSolid advisor about your situation.

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