1031
Exchange Questions
Click
here for an informative 1031 exchange brochure. (pdf)
Always
consult with your tax advisor to assure your transaction is properly structured
to qualify for tax deferred status. They are essential to a successful tax deferred
exchange. Your tax professional will establish values, allocate sales and purchase
price, and recommend the appropriate structure of your transaction.
What
does the term 1031 refer to?
1031 is the number assigned to the Internal
Revenue Code Section that provides for the tax deferred exchange of real and
personal property.
What does the term Starker refer
to?
It refers to the landmark 1979 federal case entitled, Starker
v. U.S. 602 F2d 1341 (9 th Cir 1979) wherein the court substantiated the validity
of the delayed exchange process. Prior to the Starker case, the courts had never
sanctioned an exchange whereby the relinquished property was sold and - at a later
date - the replacement property was purchased.
What
are “Safe Harbors”?
This term refers to the rules established
by the 1994 Treasury Regulations for tax deferred exchanges which provide that
- if followed - the IRS will allow the exchange to qualify.
Why
is the tax deferred exchange a popular financial planning tool?
If done
correctly, investors defer tax due in connection with the sale of real or personal
property, enabling them to access their equity to consolidate, diversify, leverage
or relocate their investments.
Why use a Qualified Intermediary?
Use of a Qualified Intermediary is sanctioned as a safe harbor by the IRS.
What is like kind?
Real or personal property
of the same nature or quality is like kind. Generally, real property is like kind
to all other real property, except foreign real property, as long as it is held
for investment or the productive use in a trade or business. Personal Property
must be either the same General Asset Class or Product Class.
How
do I properly identify my replacement property?
Property is properly
identified only if you unambiguously described it in a written document signed
by you and hand delivered, mailed, telecopied, or otherwise sent to the person
obligated to transfer the replacement property to you (i.e. the Qualified Intermediary
or the seller of the replacement property) or to any other person “involved
in the exchange” other than you or a person disqualified under Treas. Reg.
Section 1.1031(k)-1(k). Real property generally is unambiguously described if
it is described by a legal description, street address, or distinguishable name
(e.g. the Mayfair Apartment Building). If at the end of the identification period
- 45 days - you identified more properties than permitted by IRC Section 1031
(k)-1(b)(1) it is treated as if no replacement property has been identified and
the exchange will be disallowed.
What are the 45 and
180 day deadlines?
Beginning with the close of the Relinquished Property,
you have 45 days to identify the properties you intend to purchase and 180 days
(or the due date for your tax return - whichever is earlier) to complete the acquisition
of those properties. In addition, the 45 day identification period and the 180
day exchange period are calendar days. If the 45th day or 180th day falls on a
weekend or holiday, the deadlines still apply. There are no extensions for
Saturdays, Sundays, or legal holidays.
Is there
any way to get an extension on the 45 day or 180 day deadlines?
No extensions
are allowed on the 45 day deadline. Your identification must be received, signed,
in writing, on or before midnight of the 45th day. With respect to the exchange
period, it ends on the earlier of the 180th day or the due date (including extensions)
of your tax return for the taxable year in which the transfer of the relinquished
property occurs. Thus, if the exchange period is cut short by the earlier occurrence
of your tax filing date, you may file for an extension in order to get the full
180 day exchange period.
What is Boot?
Broadly
defined, boot is considered:
- “Cash boot” - money received
(or not reinvested) by you during an exchange. If you carry a note for your buyer,
the note is also considered cash boot.
- “Mortgage boot”
occurs when you pay off a loan on the sale of the relinquished property but do
not either get a loan for equal or greater value when you buy the replacement
property or invest additional cash equal to your debt relief. In other words,
if you choose not to get a loan on the replacement property, it is perfectly acceptable
to simply come up with the additional cash required to purchase the replacement
property.
- Any type of replacement property received that is
not like kind.
If I own a property with another investor,
can I exchange my equity if he doesn't want to? Yes. You would want to
clearly allocate each investor's interest in the property before you sell. The
investor who wishes to exchange may do so, and the other investor may receive
cash (taxable). It is, however, very important that the investors be clear on
their intentions before entering into an exchange agreement with a Qualified Intermediary.
Once a Relinquished Property is closed where all investor parties are under one
exchange agreement, they do not have an option of dividing proceeds and buying
separate Replacement Properties.
What is a partial tax exchange?
If the equity in your investment property is $150,000 and you wanted to use only
$100,000 to purchase your replacement property and take $50,000 out to buy a new
car, you would have a partially tax deferred exchange. The $50,000 cash you took
to purchase the car is considered taxable cash boot.
May
I take out my basis and reinvest only the gains?
No. Both basis and gains
must be reinvested to defer taxes. The IRS does not allow you to allocate a portion
of the money as basis and a portion as gain. Any money received by you will be
considered boot and taxed at a capital gain rate.
Can
a carry-back note, drawn in the name of the Exchanger, be assigned to the Qualified
Intermediary as part of an Exchange?
No. Once the Note is received in
your name, it will be taxable boot. Alternatively, to use the note as part of
the 1031 exchange, the note and deed of trust must be drawn in the Qualified Intermediary's
name.
What is the net value of the property?
Simply stated, the net value is your sales price less your closing costs. You
are responsible for reinvesting both the cash and the loan amount when you purchase
the replacement property.
How does the note become part
of the exchange?
The note must be drawn in the name of the Qualified
Intermediary. During the 180 day exchange period, you have several options in
using the note as part of the exchange:
- Sell the note to a buyer
and liquidate it to cash that is then added to the exchange proceeds and applied
to the purchase price of the replacement property;
- Obtain the
agreement of the replacement property seller to accept the note as part of the
purchase price to be paid for the replacement property;
- Accept
only a short-term note (i.e. due in less than 6 months) that will be paid off
in full prior to the acquisition of the replacement property. Payments received
are added to the exchange funds and used to purchase the replacement property.
I own a piece of property that has my own primary
residence as well as a rental unit, would it still qualify for an exchange?
Yes, so long as you remain consistent with your past tax returns. Consult
with your tax advisor to determine the percentage of the value of the property
you have attributed to investment. You may exchange that portion of the value.
How long must I hold a property for investment before I
can move into it for my own residence?
The IRS has never established
any rule for a required holding period for investment property to qualify under
IRC Section 1031. If you are considering converting investment property to a principal
residence, we strongly recommend that you consult with your tax advisor.
What
does the term “disqualified party” refer to?
The 1994 Treasury
Regulations provide that certain persons/entities are disqualified from acting
as a Qualified Intermediary. Disqualified persons include anyone who can be considered
your agent, anyone who is a related person as defined in the Code, or anyone who
bears a relationship as your agent as described in the Code. Your agents include
anyone who has acted as your employee, attorney, accountant, investment banker,
real estate agent or broker within the previous two years.
Can
I exchange with a related party?
Yes, subject to certain restrictions
- namely a two year holding requirement — you may sell property to or swap
property with a related party. If you engage in an exchange with a related person,
you are entitled to non-recognition of gain only if the replacement property is
held by you for at least 2 years and the relinquished property is held by the
related person for at least 2 years after the date of the last transfer in the
exchange transaction. Related persons include members of your family and descendents,
corporations, tax-exempt organizations and partnerships that are controlled or
owned by you. The grantor, fiduciary and beneficiary of a trust are also considered
related parties. It is not advisable to buy property from a related party.
Do
I have access to my money during the exchange?
During the exchange transaction
your exchange proceeds are placed in an exchange trust account so that you do
not have actual or constructive receipt of the funds. If you have not identified
property, you may not receive the exchange funds until after the expiration of
the 45 th day. If, however, you have identified property but you later decide
not to exchange you may not have access to the funds until the expiration of the
180 day exchange period. (Some limited exceptions apply.)
What
are exchange expenses?
Certain expenses incurred in selling the property,
which include but are not limited to the real estate commission, exchange fees,
legal fees and transfer taxes, may be paid with exchange proceeds thereby reducing
the amount that must be reinvested in the replacement property.
Click
here for an informative 1031 exchange brochure. (pdf)
