§1031 Basics

Any individual who is authorized to act on the Exchanger’s behalf –- such as the investor’s attorney, CPA, Realtor, or Financial Advisor -- cannot serve as the Qualified Intermediary for the §1031 Exchange.

IRC §1031 allows an Exchanger to exchange any kind of investment real property for any another investment real property. The property must be held for productive use in a trade or business or for investment, and it must qualify as “like kind.”

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."

Internal Revenue Code, Section 1031

Yes, the following additional rules apply to §1031 Exchange transactions:

THE LIKE-KIND PROPERTY RULE
Properties exchanged must be of “Like Kind.” Real property cannot be exchanged for a different kind of investment such as an airplane.

THE EQUAL OR GREATER VALUE RULE
In order to defer all capital gains tax, the Replacement Property should be of equal to or greater value than the Relinquished Property.

USE ALL PROCEEDS FROM THE SALE RULE
The owner/seller should use all of the proceeds from the sale of the Relinquished Property to acquire the Replacement Property in the §1031 Exchange.

THE EQUAL OR GREATER DEBT AND VALUE RULE
Generally, the debt, or mortgage, on the Replacement Property should equal or be greater than the debt on and the value of the Relinquished Property. However, the person doing the §1031 Exchange can opt to carry less debt on a Replacement Property if cash is added from other sources (e.g., personal savings.) All the cash must be used in the purchase and all the debt must be rolled over.

THE SAME OWNER RULE
The person who sells the Relinquished Property must be the same person who acquires the Replacement Property.

THE TIMING RULES
To make a valid exchange, the Exchanger must:

1. Identify the Replacement Property within 45 days of the sale of the Relinquished Property, and

2. Complete the entire exchange process by the earlier of either:

- the date the tax return is due, or
- 180 days after the sale of the Relinquished Property.

If the tax return is due before the 180-day period is over, the exchange period can be extended by filing for an extension of the tax due date.

THE IDENTIFICATION RULE
The Exchanger must submit a signed, written statement to an unrelated third party – such as the Qualified Intermediary – identifying potential replacement properties no later than 45 days after closing on the Relinquished Property. The Replacement Property must satisfy one of the following rules:

1. The Three Property Rule: Identify three properties regardless of their market value.

2. The 200% Rule: Identify any number of properties as long as their combined fair market value does not exceed 200% of the fair market value of all relinquished properties.

3. The 95% Rule: Identify any number of properties, no matter what the aggregate fair market value, provided that 95% of the value of the identified properties are acquired.

THE NAPKIN RULE
If the Exchanger purchases a property of lesser value, he/she will be responsible for any tax on the difference. The Exchanger must also use all the cash proceeds from the sale on the purchase in order to completely defer the applicable capital gains tax.

THE RULES OF CONSTRUCTIVE RECEIPT
If the Exchanger is in constructive receipt of all or any portion of the proceeds from the sale of the Relinquished Property, those proceeds are taxable.

With the exception of natural disasters, the IRS does not allow any extensions on the 45 or 180-day deadlines.

Yes. The deadlines are determined by calendar days. There are no extensions or exceptions other than the rare case of an extension granted due to a disaster or emergency.

Many factors can affect the validity of a §1031 Exchange, but the following are basic rules that apply to most §1031 Exchanges. Main rules include: The Like-Kind Property Rule - IRC §1031 allows a property owner to exchange one investment property for another investment property that is considered ‘like-kind’. With real estate, the owner can exchange any investment property for another real property. Real property cannot, however, be exchanged for a different kind of investment such as an airplane. However, the owner cannot include his/her personal residence in the §1031 Exchange.

The Equal or Greater Value Rule - In order to defer all capital gains tax, the new / Replacement Property should be of equal or greater value than the Relinquished Property (the original property being sold).

The Identification Rules - The Exchanger must submit a signed, written statement to an unrelated third party – such as the Qualified Intermediary -- identifying potential replacement properties no later than 45 days after closing on the Relinquished Property. To qualify, the potential Replacement Property(ies) identified must satisfy one of the following rules:

· The Three Property Rule: Identify three properties regardless of their market value.

· The 200% Rule: Identify any number of properties as long as their combined fair market value does not exceed 200% of the fair market value of all relinquished properties.

· The 95% Rule: Identify any number of properties, no matter what the aggregate fair market value, provided that 95% of the value of the identified properties are acquired.

IRC §1031 allows a property owner to exchange one investment property for another investment property that is considered ‘like-kind’. With real estate, the owner can exchange an investment property – such as an apartment complex – for another investment property – such as another apartment building, or a shopping mall or vacant land. However, real property cannot be exchanged for a different kind of investment such as an airplane. Also , an owner cannot include his/her personal residence in the §1031 Exchange.

Yes, but restrictions apply. For example, a two-year holding requirement applies to most exchanges between related parties.

Yes, but any cash the Exchanger receives or other gain realized (e.g., reduced indebtedness, non-qualified property, etc.) is considered boot and is taxable.

There are no federal regulations overseeing §1031 exchanges and QIs. That is why it’s so important to investigate thoroughly before choosing a Qualified Intermediary

There are no specific IRS rulings on this issue. The Exchanger should discuss that issue with a tax advisor.

The Exchanger pays the capital gains tax if he/she ever sells the Replacement Property rather than exchange it for yet another investment property. The tax becomes payable when the Exchanger files his/her next tax return. The federal and state capital gains tax rates in effect at the time of the sale apply.