1031 Basics

1. What is a 1031 tax-deferred exchange?
In a usual transaction, the property owner is taxed on any gain realized from the sale. But, through a Section 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 Property for one or more Replacement Properties of Like-Kind, while deferring the payment of federal income taxes and some state taxes on the transaction.

2. What types of property qualify for a 1031 Exchange?
The properties which are being or will be held for income production (rental), investment or use in a trade or business, qualify for a 1031 Exchange. Personal residence does not qualify for 1031 Exchange treatment, although it may qualify for Section 121 Exemption treatment. Among the types of Like-Kind property that are eligible for 1031 Exchange treatment are raw land, single-family homes, hotels, multifamily dwellings, factories, commercial office buildings, shopping centers, farmland, leases of 30 years or more, quarries and oil fields. In other words, any type of real estate may be traded for another type of real estate as long as it satisfies the qualified use test. Like-Kind rules for personal property are more restrictive than those for real property. Aircraft, automobiles, trucks, office equipment, furniture, machinery, computers, musical instruments, billboards, franchise licenses, television licenses, copyrights, collectibles and oil and gas drilling equipment are just a few examples of personal property that qualify for 1031 Exchange treatment. It is important to consult with your legal and tax advisor to decide whether your property will satisfy the qualified use and Like-Kind tests, especially in the areas of personal property 1031 Exchange transactions.

3. Can I use my primary residence or second home in for a 1031 Exchange?
No, only real estate property held for business or investment purposes can be used in a 1031 Exchange. Also both the properties in the transaction must be of Like-Kind.

4. What are the benefits of using a 1031 Exchange Vs selling?
A Section 1031 Exchange is one of the few techniques existing to push back or potentially eliminate taxes due on the sale of qualifying properties. By doing so, there is 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 otherwise. It is possible to acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.

5. What are the requirements for a 1031 Exchange?
There are four basic requirements for a 1031 Exchange. Qualifying Property - The property should qualify for the exchange. There are certain types of property that are specifically excluded from Section 1031 treatment which need to be paid attention. Proper Purpose - Both the properties must be held for productive use in a trade or business or for investment. Like-Kind - The Replacement Property acquired in an exchange must be Like-Kind to the property being relinquished. 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.

^Top

6. What types of property do not qualify for a 1031 Exchange?
Stocks, bonds, partnership or Limited Liability Company (LLC) interests, personal residences and stock in trade or inventory are a few kinds of properties that do not qualify for a 1031 Exchange.

7. What is meant by Like-Kind property in a 1031 Exchange?
Like-Kind property is real estate or other tangible property that is similar in nature or characteristics in a 1031 Exchange. Whether two properties are of "like kind" can also be dependent on state's own definition of law on the subject.

8. Is section 1031 Exchanges limited only to real estate?
No. Any property which is held for productive use in a trade or business, or for the purpose of investment, can qualify for tax-deferred treatment under Section 1031. In fact, many exchanges are "Multi-Asset Exchanges", involving both real property and Personal Property .

9. Who is involved in a 1031 exchange?
Investor/Taxpayer/Exchangor - As the person selling the property, you could be referred to by any of these names. Buyer - The person who will buy your property. This person pays money to the intermediary and in turn receives the deed. Qualified Intermediary (QI) - This is the role 1031 Exchange Services, LLC, plays. We ensure that all regulations are followed strictly. Placing the funds in an Escrow account until the exchange is completed is also responsibility of the Qualified Intermediary (QI). Seller - The person selling his property to you. It is not necessary that he is the same person who is purchasing your property in the exchange.

10. Can I buy or sell multiple properties in a 1031 Exchange?
Yes, multiple smaller properties can be exchanged for a larger one and vice versa. It is advisable to always trade up in value, in order to maximize the amount of Capital Gain taxes that are deferred.

11. How long must a property be held before I can do a 1031 Exchange?
Internal Revenue Codes and regulations do not state a specific time that property must be held for a Section 1031 Exchange. However, the most important issue is the intent of holding and not the period of holding. The property must be held for "use in a trade or business or for investment" and exchanged for Like-Kind Property .

12. Are 1031 Exchanges difficult?
Entering into a 1031 Exchange with an experienced qualified intermediary, such as 1031 Exchange Services, LLC couldn't be easier. The Investor simply contacts us and executes an exchange agreement. From that point onwards it's the duty of 1031 Exchange Services, LLC to conduct its own investigations and negotiating with other parties. With the experienced staff at 1031 Exchange Services, LLC we contact the closing attorney to ensure that the closing complies with the requirements of the Code and Regulations.

Property Identification

13. Is there any limit to the number of properties that can be identified?
There are 3 rules that limit the number of properties that can be identified. The taxpayer must meet the requirements of at least one of these rules. They are
(1) Three Property Rule
(2) 200 Percent Rule and
(3) 95 Percent Rule

14. How do I identify exchange property?
There are stringent requirements regarding identification of Replacement Property. These requirements must be met before the expiration of 45 days from the date you relinquish your exchange property. All replacement property must be identified in writing. It must then be signed by you, and delivered to us on or before the 45th day. You may identify as many as three properties, regardless of their total value (the "3 Property Rule"). If you stay within these rules, it is not required to acquire all the property you identified. It may be kept in mind that there are serious consequences if you do not stay within frame work of either of these rules. We strongly recommend that you follow the 3 Property Rule, and identify either two or three properties, so that if the closing on your preferred property fails for any reason, you will have made a timely identification of one or two alternate properties which can be acquired instead. You may identify any type of Like-Kind Property. You may identify property in any State of the United States. Your identification must be specific as to what you intend to purchase and the purpose. It may be noted that there are restrictions on acquiring property from related persons. Please call us, if you plan to do so.

^Top

15. Can I exchange unimproved real property for improved real property?
Yes. Improved real property is Like-Kind and can be exchanged for unimproved real property and vice versa. Real estate is Like-Kind to real estate so long as it is held for productive use in a trade or business or for investment purposes.

Qualified Intermediary (QI)

16. Who is a Qualified Intermediary and what is his role?
Qualified Intermediary (QI) is a third party who helps to facilitate the exchange. He is also known as Accommodator, Facilitator, and Qualified Escrow Holder. Most importantly he is not a related party to the Exchangor. His job is to facilitate the disposition of the Exchangors Relinquished Property and the acquisition of the Exchangors Replacement Property. The QI has no monetary interest in the exchange process except for the fees charged towards his services. As a professional, Qualified Intermediary (QI) is a member of the Federation of Exchange Accommodators and is bonded by its guidelines.

Tax Deferral Vs Tax Saving

17. What exactly are the tax advantages in exchanging?
By entering into the exchange payment of any kind, Capital Gain taxes can be eliminated. Even paying of higher-rate taxes can be eliminated on the recapture of depreciation you have taken on your property. By exchanging into a higher priced property you'll also gain additional depreciation deductions which can in other words increase your after-tax income.

18. Are there any other reasons to exchange except for tax advantages?
Yes, there are many other reasons too. For example, if you no more like the existing property, it can be exchanged for NNN Triple Management free property or multiple smaller properties for the very reason that they can be professionally managed. Also if re-finance is not possible in the current property, it can be exchanged for a new property, which can be refinanced more easily.

19. Can I get money out of the exchange tax free?
Yes, it can be done by completing the exchange first and then refinance the new property.

20. Can I get legal or tax advice from you?
No, the IRS doesn't permit us to act as both Qualified Intermediary (QI) and attorney or tax advisor for an Investor. However, it is our job to work with your attorney and CPA to make sure that your tax free exchange is done smoothly.

21. Will an exchange increase my chances of an audit?
It is unlikely that the chances of your audit are to increase because of a 1031 Exchange. Since tax free exchanges are specifically authorized by statute, an Exchangor would have nothing to fear from an audit if the exchange is structured correctly.

22. Can I refinance without blowing the tax free exchange?
Yes, refinancing of the property before selling or buying is permissible; but only after the exchange process is complete. In this case the proceeds are tax-free. It may be noted that timing and contract dates are critical.

23. Do I need to find someone to exchange my properties, in order to effectuate a tax free exchange?
In order to accomplish a tax free "exchange", undoubtedly there must be an exchange of properties. However, this does not mean that you sit down with another property owner and just trade deeds. It would be not be practical to find another person with investment property of identical value who wants to make a swap.

Partnerships

24. Are partnerships allowed to do exchanges?
Partners are allowed to do exchanges. But the Code is very clear that individual partners are not to exchange their partnership interest for another partnership interest or for real property.

Exchanges Types and Rules

25. What are the other types of exchanges?
Single Property-Two/Three Party, Multi-Party/Multi Property Exchange, Simultaneous Exchange with Intermediary, Deferred Exchange with Intermediary, Construction/Improvement Exchanges, Leasehold Improvements Exchanges, Vacation Home Exchange, Mixed Use Property, Installment-Sales, Government Entities as Parties and Condemnation, Reverse Exchange and Casualty Proceeds are the other types of exchanges.

^Top

26. What is a "multi-asset" exchange?
A Multi-Asset Exchange involves both real and personal property. If you intend to sell a hotel then it will include the underlying land and buildings, as well as the furnishings and equipment. If the Taxpayer wants to exchange the hotel for a similar property, then he would exchange the land and buildings as one part of the exchange. The furnishings and equipment would be separated into groups of Like-Kind or like-class property. The groups of Relinquished Property will then be exchanged for groups of Replacement Property. Even though the definition of Like-Kind is much narrow for personal property and business equipment, careful planning will allow the taxpayer to enjoy the benefits of an exchange for the entire Relinquished Property and not just for the real estate portion.

27. What are the specific timing rules for an exchange?
The Exchangor has a maximum of 180 days from the closing day of the Relinquished Property or the due date of that year's tax return, whichever occurs earlier, to acquire the Replacement Property. This is called the Acquisition Period. The first 45 days of that period is called the Identification Period. During this period, the exchangor must identify the property for replacement. The identification must be in writing, signed by the exchangor, and received by the facilitator or other qualified party, faxed, postmarked or otherwise identifiably transmitted. Failure to identify Replacement Property within the 45 day period will cause the exchange to fail.

28. Can I buy a new property before selling my old one?
Yes, a new property can be brought before selling the old property and can still qualify for the 1031 Exchange. This process is also called as 'Reverse Exchange'. In this process the Qualified Intermediary (QI) takes title to the new property and holds it till such time the old property is sold.

29. Can I trade for my property in one State for a property in another?
Yes, 1031 Exchanges are applicable anywhere in the United States, but be advised, some States have special rules affecting exchanges in their State only.

30. How do I exchange into a larger property (trade up)?
It can be done by either adding cash, obtaining a bigger loan on the new property, adding equities in other properties, or notes carried back from the sale of other properties, etc. If done in the right manner, it's all tax free.

31. Do I have to buy raw land, if I sell raw land?
The term "Like-Kind real property" refers to the nature or character of the property and not to its grade or quality. The very fact that any real estate is improved or unimproved is immaterial. Technically, all US real estate (no matter what the form) is Like-Kind real property and improved real estate which can be exchanged for unimproved real estate; a city real estate may be exchanged for a farm…..etc

32. Can I do an exchange if I use my property partially as a residence and partially as a rental property?
Yes, it is possible. However, in such an exchange, allocation of value between the two types of property becomes important.

33. Do I have to sell and buy on the same day?
The tax code allows for "deferred like-kind exchanges". In a deferred like-kind exchange, the investor sells the real estate ("Relinquished Property ") to any unrelated buyer, and then has 45 days to find ("identify") property they wish to buy ("Replacement Property"). Although the Replacement Property must be identified within 45 days, the investor has the lesser of 180 days or the due date of its tax return for the year of the sale (which such return can be extended) from the sale of the Relinquished Property to close on the Replacement Property.

^Top

34. What is "boot"?
Boot is defined as any "non like-kind exchange" property which received by the Exchanger in the exchange and is taxable. Cash Boot and Mortgage Boot or Debt Relief are the various kinds of boots.

35. Is it possible to offer an exchange to my lender in lieu of foreclosure?
As there is every likely hood that there is a taxable Capital Gain and depreciation recapture even if there is no remaining equity. Also there being several other complexities to consider, it is always best to consult your CPA or tax advisor.

36. Should I spend all of the proceeds from my relinquished property on replacement property?
No, it is not a must. However it may be noted that you will be taxed on the amount you don't spend. Unused proceeds are known as "Boot" and are taxed on their face value.

37. If I don't spend all my proceeds when can I receive the unused amount?
The unused proceeds can be taken at anytime after you have acquired each one of the properties identified in your 45 Day Identification. But, if you do not acquire all of the properties identified in the 45 Day Identification, then the unused proceeds cannot be released until the earlier of the due date of your tax return including extensions, or Exchange Period(180 Days) after the closing of the sale of the Relinquished Property.

38. If you have already signed by sales contract, is it too late to effectuate a 1031 Exchange?
1031 Exchange Services frequently receives calls from investors at the closing, asking us to prepare the necessary paperwork to get the exchange in motion. Until title has passed to the buyer and money has been received, it is not too late to set up an exchange.

39. Should the names on the deeds be the same for both the relinquished property and the replacement property?
Yes, unless a disregarded entity is involved. IRC § 1031 recommends that no gain or loss will be recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a Like-Kind. If the exchanger changes the form of ownership of the property contemporaneously with the exchange, the IRS argues that the exchanger held the property primarily to dispose of it, which is a nonqualified use rather than for productive use in a trade or business which is called a qualified use.

40. What happens if I can't acquire the properties I identify?
If an exchanger is not able to acquire identified property, the exchange funds will be returned to the exchanger. The exchanger will then recognize the gain realized on the sale of the Relinquished Property. The timing of the payment of the exchange funds may sometimes creates a problem. The regulations under Section 1031 allow a payment of money to the exchanger upon the earliest to occur of three events: (1) the end of the Exchange Period(180 Days); (2) the end of the 45 Day Identification if the exchanger has no remaining unacquired identified Replacement Properties; or (3) when there are remaining unacquired identified properties at the end of the identification period, then on (a) receipt of all properties that an exchanger is entitled to receive under the exchange agreement, or (b) the occurrence of a "material and substantial contingency that relates to the deferred exchange", that is to be provided for in writing, and is beyond the control of the exchanger or any disqualified person.

41. Do I need the cooperation of my buyer and seller to do the exchange?
Not necessarily. The regulations only require that the Buyer and Seller be given notice of the exchange. 1031 Exchange Services prepares a "Notice of Assignment" which provides the required notice. Although cooperation is not required, we recommend that the purchase and sale agreements for both; the sale and purchase of real estate contain language requiring other parties to cooperate. This prevents a suddenly reluctant party from pointing to the 1031 Exchange as a reason to not go forward.

^Top

Tenancy-in-Common

42. What is a Tenancy-In-Common?
Tenanancy In Common (TIC) is a form of ownership of real property where two or more individuals own an undivided interest in the property. Upon the death of one of the owners, the interest passes to the owner's heirs. Interests in tenancies-in-common are usually divisible, and can be placed into a 1031 Exchange independently

43. Does my attorney hold the sales proceeds in escrow while I look for a replacement property?
No. The regulations do not permit the investor's agent, broker, attorney, accountant, most family members and others with a relationship with the Investor to hold the sales proceeds. The Investor should use a reputable Qualified Intermediary (QI) that has instituted financial safeguards to protect the sales proceeds during the exchange.

44. Are 1031 Exchanges only for the big investors?
No. Actually, anyone who owns investment property should consider a 1031 Exchange before selling. Even if they are selling a small rental unit or an office building, they can simply pay the gain and throw away their hard earned money, or affect a 1031 Exchange which will preserve their capital. Any Investor should consult a tax adviser who is familiar with 1031 Exchange to determine the most beneficial strategy.

45. Can I carry back a loan on the property I'm selling and still have a tax free exchange?
Yes, the payments received on an installment sale basis are taxable. The balance of your equity is exchanged tax free.

46. Can I still do an exchange if I have already sold my property?
Yes, the exchange is possible provided the sale has not closed yet. You have to simply contact 1031 Exchange Services LLC and we will turn your taxable sale into a tax free exchange with some simple paperwork.

47. What are the fees for a 1031 Exchange?
The fees charged by 1031 Exchange Services, LLC varies based on the type of exchange and number of properties involved. Our fees start from $450 for one relinquished property for one replacement property. Please call for an actual quote which may vary depending on complication of the transaction involved. As a rule of thumb, more complicated the exchange, higher would be risk for the accommodator and therefore so would be the fees.

48. So when and how do we begin?
Once you have decided to do a 1031 Exchange, call us at Toll Free No. 866-712-1031. There's no charge. Our expert will answer all the questions you have. By calling today, you'll be glad you did it right away! If you would like us to call, kindly leave your message at contact us.

^Top