Frequently Asked Questions
|What is a 1031 Exchange?|
According to section 1031 of the Internal Revenue Code, a titleholder may exchange like kind property tax-deferred through a process called a 1031 Exchange. In order for this to be done properly, the titleholder needs to go through a Qualified Intermediary and follow the 6 IRS Rules:
Real Property Use- Both the old and the new property must qualify as held for investment or income producing.
45-Day Identification Period- You have 45 calendar days from the closing on the sale of your relinquished property to identify up to 3 replacement properties you would like purchase.
180-Day Exchange Closing Period- From the sale of the closing date of the relinquished property, you have 180 days to purchase and close on a property that must be listed on your 45-day form.
Qualified Intermediary- The IRS mandates that you use a QI to prepare legal documents for your exchange and hold your money during the exchange. Your QI must be an independent third party, and cannot be a friend, employee, broker, or even your CPA or Attorney.
Proper Title Holding- You must purchase and hold title to the new property exactly as you held title to the old.
Reinvestment Requirement- To defer all of your capital gains tax, you must buy a property equal or higher in value than the one you sold.
Is a 1031 Exchange tax free?
A 1031 exchange is tax deferred, meaning you are putting paying the taxes off until another time. There are two ways that you can make the 1031 exchange tax free: 1) You hold onto the replacement property until you die, or 2) You roll over your replacement property into another 1031 exchange, and continue to defer taxes. Essentially, you can continue to do this until you die. Should you sell your replacement property outside of a 1031 exchange, the taxes that were deferred will then need to be paid off.
|How do I choose a Qualified Intermediary?|
This is an important question, as your QI will be the person preparing your legal documents for the exchange, and holding your money during the exchange period. Qualified intermediaries are not regulated by the government, so you will want to make sure that you find one who you can trust. We suggest finding a QI who is bonded and insured. Here at 1031 Exchange connection, we are bonded and insured, have close relationships with our local banks where the funds are held, and keep all of our client's exchange funds in separate, non-comingled accounts.
What does like kind property mean?
In a 1031 Exchange, an investor is to exchange their investment for a like kind property. Like kind does not mean that the properties have to be exactly the same (i.e. if you are selling a piece of land, you don't have to purchase just a piece of land). Rather, it refers to the use of the property. In a 1031 property exchange, the old property as well as the new should be held as investment or utilized for a business or trade.
Does my property qualify for a 1031 Exchange?
With the exception of the safe harbor ruling, there are no exact guidelines that defines which properties qualify for a 1031 exchange. Rather, the IRS is looking for intent—did you intend to purchase this property for long term investment purposes? Therefore, we recommend that both the property you are selling and the property you are purchasing are intended to be income producing and held for at least a year and a day.
Some examples of this would be:
A building that is used for a business or trade
A dwelling that has been rented to tenants at a fair market value
A piece of land (although cannot be income producing, is always considered held for investment)
Not all property is ideal for a 1031 Exchange. Here are some properties that could be risky to do a 1031 exchange:
Your principal, or homesteaded, residence.
A second home that is not income producing (no renters).
A property strictly held for resale (used as a “flip”). The IRS frowns upon this, so as a general rule we tell clients to hold onto their investment property for a year and a day.
These properties could show to the IRS that your intent was not for a long term investment, and you would risk your exchange being disallowed if audited by the IRS.
Let’s take a look at some examples of situations we have soon in our years of experience:
Example 1: Jim and Sue own a beach condo in Florida. They use it for their personal vacation two months out of the year, but rent it out to others for the rest of the 10 months. They would like to do a 1031 Exchange and purchase a log cabin in the mountains of Asheville, NC to continue to use for vacation, but also rent out other times of the year. Would these properties qualify in a 1031 Exchange?
Yes. The old property was held for investment, and the intent of the new property is also for investment, so this would qualify Jim and Sue for a 1031 Exchange.
Example 2: Ron bought a home, made some renovations, and is now selling it only 2 months later. He would like to do a 1031 Exchange and purchase another home. Does he qualify?
No. In this situation, the intent of his property is held for resale, which would not qualify for a 1031. However, if Ron decides to rent it out and hold onto it for another year or two, he can then do a 1031 Exchange.
To read more about selling your investment property in a 1031 exchange, please visit Selling Investment Property in 1031 Exchange
Can foreign property be exchanged for US property?
No, U.S. property must be exchanged for U.S. property. However, a foreign investor may do 1031 exchanges if both the old and new are pieces of U.S. property.
I would like to do a 1031 exchange, but I would like to buy the replacement property before the sale of the old property. Is this possible?
The answer is yes! A Reverse 1031 Exchange allows the exchanger to acquire their like kind replacement property first, then sell their old property within the guidelines of a 1031 Exchange. The issue with the IRS is they will not allow you to hold title to both the old and new properties at the same time during a 1031 exchange, as by their very own definition that would disqualify the exchange.
The IRS issued a ruling (revenue procedure 2000-37, a “Safe Harbor”) which allows your Qualified Intermediary to take title to your new property first and hold it until the old one sells. As Qualified Intermediaries, we create an Exchange Accommodator Titleholder (EAT) to take title to your new property (usually in an LLC), and we “park” it there until the old property is sold. This is how the IRS allows you to only hold title to one property at a time, and not turn it to “toast” during the exchange.
Once your Qualified Intermediary has taken title to the new property, you have 45 days to identify the property you want to sell, 180 days to sell it, and then get into title to the new property the QI is holding for you. To read more about Reverse 1031 Exchanges, please go to Reverse 1031 Exchange