If you are monitoring the intricacies of several
1031 Tax Exchanges, our team of specialists can assist you in installing and configuring our TrackExchange software.
It is Windows-based, and assumes a reasonable level of understanding of Section 1031 of the IRS Revenue Code.
If you are still in the mode of investigating how 1031 exchanges work, please review the FAQ’s below, before calling us to discuss our software.
Our software design is based on specifications provided by FORT Properties, Inc., one of the nation's leading real estate investment companies, and a premier sponsor of Section 1031 tax-deferred, tenant-in-common (TIC) fractional ownership offerings.
These "Frequently Asked Questions" are to answer general inquiries. Each 1031 Tax Exchange transaction is unique. The application of the principles below depends on the specific details of each transaction. Make sure you always consult a tax advisor to determine how an exchange may best be structured to meet your investment objectives. If you wish professional assistance in understanding the subtleties of 1031 tax exchanges, an excellent source would be FORT Properties, Inc., in Los Angeles, Ca. They specialize in 1031 exchanges, and their knowledgable staff can answer any questions you may have.
Q: What is a 1031 tax deferred exchange?
Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031.
In a typical transaction, the property owner is taxed on any gain realized from the sale. However, through a 1031 Exchange, the tax on the gain is deferred until some future date.
Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of "like-kind", while deferring the payment of federal income taxes and some state taxes on the transaction.
The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer's investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a "paper" gain.
The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.
Q: What are some of the benefits of exchanging versus selling?
The Section 1031 exchange is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.
By deferring the tax, you have more money available to invest in another property. In effect, you receive an interest free loan from the federal government, in the amount you would have paid in taxes.
Any gain from depreciation recapture is postponed.
You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.
Q: What are the different types of exchanges?
Simultaneous Exchange: The exchange of the relinquished property for the replacement property occurs at the same time.
Delayed Exchange: This is the most common type of exchange. A Delayed Exchange occurs when there is a time gap between the transfer of the Relinquished Property and the acquisition of the Replacement Property. A Delayed Exchange is subject to strict time limits, which are set forth in the Treasury Regulations.
Build-to-Suit (Improvement or Construction) Exchange: This technique allows the taxpayer to build on, or make improvements to, the replacement property, using the exchange proceeds.
Reverse Exchange: A situation where the replacement property is acquired prior to transferring the relinquished property. The IRS has offered a safe harbor for reverse exchanges, as outlined in Rev. Proc. 2000-37, effective September 15, 2000. These transactions are sometimes referred to as "parking arrangements" and may also be structured in ways which are outside the safe harbor.
Personal Property Exchange: Exchanges are not limited to real property. Personal property can also be exchanged for other personal property of like-kind or like-class.
Our software is designed to handle all of the above types.
Q: What are the requirements for a valid exchange?
Qualifying Property - Certain types of property are specifically excluded from Section 1031 treatment: property held primarily for sale; inventories; stocks, bonds or notes; other securities or evidences of indebtedness; interests in a partnership; certificates of trusts or beneficial interest; and choses in action. In general, if property is not specifically excluded, it can qualify for tax-deferred treatment.
Proper Purpose - Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify. The taxpayer's personal residence will not qualify.
Like Kind - Replacement property acquired in an exchange must be "like-kind" to the property being relinquished. All qualifying real property located in the United States is like-kind. Personal property that is relinquished must be either like-kind or like-class to the personal property which is acquired. Property located outside the United States is not like-kind to property located in the United States.
Exchange Requirement - The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property. Most deferred exchanges are facilitated by Qualified Intermediaries, who assist the taxpayer in meeting the requirements of Section 1031.
Q: What are the general guidelines to follow in order for a taxpayer to defer all the taxable gain?
The value of the replacement property must be equal to or greater than the value of the relinquished property.
The equity in the replacement property must be equal to or greater than the equity in the relinquished property.
The debt on the replacement property must be equal to or greater than the debt on the relinquished property.
All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.
Use our analysis tools in our TrackExchange software to help you analyze these options.
Q: When can I take money out of the exchange account?
Once the money is deposited into an exchange account, funds can only be withdrawn in accordance with the Regulations. The taxpayer cannot receive any money until the exchange is complete. If you want to receive a portion of the proceeds in cash, this must be done before the funds are deposited with the Qualified Intermediary.
Q: What is a Qualified Intermediary (QI)?
A Qualified Intermediary is an independent party who facilitates tax-deferred exchanges pursuant to Section 1031 of the Internal Revenue Code. The QI cannot be the taxpayer or a disqualified person.
Acting under a written agreement with the taxpayer, the QI acquires the relinquished property and transfers it to the buyer.
The QI holds the sales proceeds, to prevent the taxpayer from having actual or constructive receipt of the funds.
Finally, the QI acquires the replacement property and transfers it to the taxpayer to complete the exchange within the appropriate time limits.
Q: What are the time restrictions on completing a Section 1031 exchange?
A taxpayer has 45 days after the date that the relinquished property is transferred to properly identify potential replacement properties. The exchange must be completed by the date that is 180 days after the transfer of the relinquished property, or the due date of the taxpayer's federal tax return for the year in which the relinquished property was transferred, whichever is earlier. Thus, for a calendar year taxpayer, the exchange period may be cut short for any exchange that begins after October 17th. However, the taxpayer can get the full 180 days, by obtaining an extension of the due date for filing the tax return.
Q: What if the taxpayer cannot identify any replacement property within 45 days, or close on a replacement property before the end of the exchange period?
Unfortunately, there’s no extensions available. If the taxpayer doesn’t meet the time limits, the exchange will fail and the taxpayer will have to pay any taxes arising from the sale of the relinquished property, unless the IRS has expressly granted extensions in specified disaster area(s).
Q: Is there any limit to the number of properties that can be identified?
There are three rules that limit the number of properties that can be identified.
The taxpayer must meet the requirements of at least one of these rules:
3-Property Rule: The taxpayer may identify up to 3 potential replacement properties, without regard to their value; or
200% Rule: Any number of properties may be identified, but their total value cannot exceed twice the value of the relinquished property, or
95% Rule: The taxpayer may identify as many properties as he wants, but before the end of the exchange period the taxpayer must acquire replacement properties with an aggregate fair market value equal to at least 95% of the aggregate fair market value of all the identified properties.
You may use our analysis tools to assist you in choosing the rule appropriate for you.
Q: Do you have any referrals for companies that can assist me with 1031 exchanges, and especially with locating replacement property?
There are several excellent companies out there.
We highly recommend:
The Pepper Group (Arizona only)