1031 Exchange FAQ

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Common 1031 Exchange Questions

How does the 1031 Exchange 95 percent % rule for identifying replacement properties work?

My dad died before he finished his 1031 Exchange. What do I do?

Can I 1031 exchange property held for personal use for property held for productive use? Why not?

In a 1031 Exchange, what type of property can farm land be traded for?

How do I take back proceeds from my 1031 Exchange?

Are 1031 Exchange Qualified Intermediary Escrow Accounts safe?

The Safe Harbors required to conduct a 1031 Exchange insist that your 1031 Exchange proceeds are stored in an escrow account held by your Qualified Intermediary. It should be understood that not all QI accounts are created equal. Insist that your Qualified Intermediary pay to have every penny of your 1031 Exchange proceeds FDIC insured. Many banks only offer FDIC insurance for funds up to $250,000. Few banks over this coverage on amounts higher than $250k. Another safety measure is to request that your QI establish a Qualified Escrow Account with your money, which mean that no funds are accessed without your knowledge and consent signature. As your Qualified Intermediary Realty Exchangers takes the safety of your money seriously. Review our safety protocols by clicking here.

Related Info: safe, accounts, escrow, safety, account, money, fdic, funds

In a 1031 Exchange, can I have a gain even if I don't have any boot?

YES! Believe it or not. Many people don't know or even realize them, some pros may not know it as well.

It is possible, in a 1031 exchange, to recognize gain even if not one cent of boot is received! There’s a little-known rule that can cause you to trigger the entire recapture as ordinary income even if you do not recognize gain figured under the regular exchange rules. Recapture income will be recognized if the fair market value of the depreciable property you receive in the exchange is less than the income subject to recapture. The amount of gain recognized is limited to the difference between the depreciation subject to recapture and the value of the depreciable property.

Related Info: boot, gain, recapture, income, recognized, value, depreciable

My dad died before he finished his 1031 Exchange. What do I do?

We hope your father did some decent estate planning and we hope that you are one of his heirs. This makes the 1031 Exchange title issue easier to solve.  The IRS has said that "If the exchanger dies after the exchange is commenced but before it’s completed, the exchanger’s estate may complete the exchange." You will need to work with your attorney and do changes to the title. Just remember that all of the same rules for 1031 Exchange apply in this circumstance.

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Are you sure in a 1031 Exchange that land zoned for Farming can be traded for land zoned Residential?

Under the 4 classifications of Real Estate, Real Estate held for Investment purposes such as land qualifies for IRS 1031 Exchange like-kind property. There is no mention of how the land is zoned because zoning is a city, county or state issue, and rarely is it a federal issue. So we are certain that these two types of land are considered like-kind and subject to 1031 Exchange Tax Relief. There can be some issues if either parcel of land has a residence that is being used as a primary residence. There we are getting into mixed classification issues. More on Mixed Classifications as they relate to 1031 Exchange, can be found by clicking here.

Related Info: land, zoned, residential, farming, traded, classifications, issues, residence, mixed, like-kind

I did a 1031 Exchange back in 2003 and am selling the property soon. Will I have to pay capital gain on the sale if I don't buy another property?

1031 Exchange, tax-deferred exchange, real estate exchange, like-kind exchange, IRS section 1031 Exchange....these all mean the same thing and are a vehicle for deferring the capital gains on an investment property or business property until your next sale. A common mistake that people make is with a 1031, they think they will NEVER have to pay their capital gains tax. Some tax pros and Qualified Intermediaries advertise this. This is far from true.  Yes, you can continue to defer your capital gain if you continue to purchase real estate that is of a qualifying like-kind. But if you "cash-out" a property, those proceeds are subject to capital gains. Discuss this with your CPA to determine how much your capital gains would be and see if there are other strategies available.

Related Info: sale, gain, capital, selling, 2003, gains, real, like-kind, estate, purchase

I heard I can take back cash from my 1031 Exchange proceeds. Is that true?

There are two opportunities during your 1031 Exchange where you can take back cash without disrupting the flow of the exchange. The first opportunity is at the closing of your relinquished property. During this time you may take back cash before the proceeds are transferred to your QI's trust account. The other opportunity when you have closed sale on all of your Identified Replacement Properties.

HOWEVER. Please note! The liquid cash that you receive from your 1031 Exchange is called "Boot Received" and may be subject to the capital gains tax. Careful planning of "boot received" should be discussed at length with your CPA or tax attorney.

Related Info: proceeds, cash, opportunity, boot, liquid, receive, properties

Can I 1031 Exchange my un-divided interest in a rental, without my partners?

Yes. If it says on your property deed that you have an un-divided interest in a property, you may 1031 Exchange into another property without paying the capital gains tax.

The first thing to examine is the legal status of the investor. For example, tenants in common can split up without dealing with outsiders and get §1031 treatment in the split-up. Under Rev Rul 73-476, the IRS approved this transaction. Three investors owned an undivided interest as a tenant in common. There were no mortgages on the property and the property was held for investment. Each of the three investors exchanged his undivided interest in the three separate parcels for 100% ownership of one parcel.

Sometimes, however, the investors are partners rather than tenants in common. If this is the case, the investors should seek expert legal and tax counsel regarding a tax-free liquidation in kind of the partnership properties to the investors. Then, as tenants in common, they could do a 1031 exchange.

Caution: This procedure can be risky but if the savings are substantial, it’s worth checking out with couns

Related Info: partners, rental, interest, un-divided, investors, common, three, tenants, undivided

What is a 1031 Exchange Starker Exchange?

A Starker Exchange IS a 1031 Exchange. The term Starker comes from a lawsuit case in 1979, Starker vs. U.S. (602 F.2d 1341), that a contract to exchange a property in the future is the same as a simultaneous exchange. It is this case where the delayed 1031 Exchange originated. In order to get 1031 Exchange treatment from the IRS, you need to identify the property as a 1031 Exchange before closing, identify the replacement property with 45 days of closing and acquire your replacement properties with 180 days of closing and you MUST use a Qualified Intermediary to facilitate your transaction.

Related Info: starker, closing, case, replacement, identify, treatment

I heard I could take boot from a 1031 Exchange and defer the tax. How does that work?

Yes. There is an ingenious tax strategy which will permit you to take back boot in a 1031 exchange without paying tax on it now. The Gain from the boot can be deferred into future tax years. It's done by taking back a purchase money installment note from the “buyer” of the Relinquished Property to balance all or part of the equities. When structured correctly, the taxable gain in the note may be reported using the installment method of tax accounting.

If you are an exchange specialist, be sure to tell your clients about this marvelous tax saving strategy. They will love you for it—all the way to the bank.

Related Info: work, defer, boot, strategy, method, accounting, installment, gain

I need to change my identified replacement properties. How do I do that?

The Identification of 1031 Exchange replacement properties can be revoked as long as it is done within the 45-day identification period. This revocation must be done in writing and should include a rescission of a purchase and sale agreement, if one was written. The next step would be to write a new Identification letter that includes the properties you intend to close sale on before the 45 day deadline is reached.

Related Info: properties, replacement, identified, change, identification, sale, letter, agreement, includes

Can I 1031 Exchange a property that I'm gifting to my daughter?

You should be very careful here. The IRS is quite specific regarding gifting 1031 Exchange properties. They have stated that there MUST be an actual sale in order for there to be an exchange.

You will not get 1031 Exchange benefit merely if you intend to exchange—you must actually make an exchange of your property.

Related Info: daughter, gifting, benefit, order, intend, exchangeyou, actually, sale

Can I 1031 exchange the water rights to my property?

Depends on many factors. The best place to start is to review our 1031 Exchange Knowledge Base regarding Water rights and 1031 Exchange. Here is an excerpt:
"Donald, Gary, and Deborah Wiechen were partners in a partnership, Wiechens Properties Limited Partnership, that owned land in an irrigation district. The partnership obtained the right to receive Colorado River water to irrigate its land and it was permitted to sell the water rights to the government without selling the land. The partnership retained the land but exchanged its water rights for an interest in farmland. The partners didn't report any income from the transaction, believing that it qualified for nonrecognition treatment under section 1031. The IRS made assessments against the partners for their 1993 taxes. The partners filed suit for a refund in district court. The parties filed motions for summary judgment. The partners argue that their water rights are an interest in real property, that the properties exchanged were of like-kind, and the exchange qualifies for nonrecognition treatment.
U.S. District Judge Stephen M. McNamee agreed with the partners that the water rights were an interest in real property. However, the parties disputed the duration of the water rights. The partners asserted that the water rights were perpetual, that they originated from the Supreme Court decision in State of Arizona v. State of California, 373 U.S. 546 (1963), and that the water rights were established by a Department of Interior water allocation notice, 48 Fed. Reg. 12446 (Mar. 24, 1983). Sustaining the government, the court dismissed the partners' reliance on the opinion and concluded that under a 1984 subcontract the partners were entitled to water rights for a 50-year period. Thus, the court concluded that the water rights are limited in quantity, priority, and to a 50-year duration.
Judge McNamee was persuaded by the government's argument and followed Rev. Rul. 55-749, 1955-2 C.B. 295, which discussed the exchange of water rights for a fee simple interest in land and advised that water rights of a limited amount or duration aren't sufficiently similar under §1031 to a fee simple interest in land. Thus, the court held that an exchange of nonperpetual water rights for a fee simple interest in land does not satisfy §1031. Judge McNamee denied the partners' motion for partial summary judgment and granted government's cross-motion for summary judgment."

Related Info: rights, water, partners, land, interest, court

What is the difference between Capital Gains and Equity?

Answer:  Don't confuse them, they are not the same.

Equity is the money left over once you sell a  property and pay off all the liabilities including mortgages.

Capital gain on a property would be the difference between your basis and your adjusted sales price. If you bought property for $20k (your basis) and sold it for $100k, after paying off the liabilities you would have a capital gain of $80k.

If you sell instead of doing a §1031 Exchange, you would be obligated to pay a capital gains tax on the entire $80k.

Be extremely careful not to trap yourself with a regular sale.

Related Info: equity, gains, capital, difference, gain, basis, liabilities, $80k, paying

In a 1031 Exchange, how many Replacement Properties can I have?

In a 1031 Exchange, you have 3 choices for determining how many Replacement Properties to Identify. These are the 3 Identification rules set down by the IRS for 1031 Exchange. You may choose which of these rules to follow at any time during the 45 day Identification period. One you have chosen which rule to follow, you may not change your mind after the 45 day deadline.
The 3-Property Rule
The maximum number of replacement properties you may identify is three properties without regard to fair market values of the properties.
The 200 Percent Rule
You may identify any number of properties as long as their total fair market value does not exceed 200 percent of the total fair market value of all Relinquished Properties. You figure fair market value of Replacement Property as of the end of the identification period. You figure fair market value of Relinquished Properties as of the date you transfer them. If, as of the end of the identification period, you have identified more properties as replacement properties than permitted, you are treated as if no Replacement Property has been identified.
The 95 Percent Rule
You may identify any number of Replacement Properties if during the Exchange Period you actually received identified Replacement Properties having a fair market value equal to or more than 95 percent of the total fair market value of all identified Replacement Properties.
Special Exception
Any Replacement Property received by you before the end of the identification period is treated as being properly identified under the Identification Rules.

Related Info: properties, replacement, fair, market, value, identification

Can I 1031 Exchange a rental property and purchase a primary residence with the proceeds?

No. 1031 Exchange rules require that the relinquished property and the replacement property be of like-kind. What this means is that they both must be either a business property such as a rental or an investment property, such as land. The sale you mention will incur the capital gains tax. If your goal is to defer those taxes, your 1031 Exchange replacement property must be of like-kind qualify for IRS 1031 Exchange.

Related Info: proceeds, residence, primary, purchase, rental, like-kind, replacement, gains, capital, incur, goal

I already sold my rental home. Is it too late to 1031 exchange it?

A 1031 Exchange happens at the closing of sale on Relinquished and Replacement Properties. This is usually when the transfer of title happens. If in the case of a property that you already closed sale on and transferred the title, no, you cannot 1031 Exchange it for something else. However, if you haven't completely closed sale on your property and title hasn't transferred and you haven't accepted the proceeds,  there is still time to 1031 Exchange your property. If you find yourself in this situation where you haven't completely closed on your investment or business property, please call your Qualified Intermediary today at 800-570-1031.

Related Info: home, rental, title, closed, haven't, sale, completely, transferred

I want to 1031 Exchange land for a "park" model in an RV park for use as a vacation rental. Can I do this?

You need to check with your specific state and and find out if the "park" model is classified and treated as real property (not personal property) in the state where it is located. Many states treat it this way, some do not. If you can get the real property classification from the state, a 1031 Exchange should be permitted by the IRS as you would be exchanging like-kind property.

Related Info: park, rental, vacation, model, land, state, real, treat, states, classification, permitted

Can I 1031 Exchange my 30% interest in an LLC that owns commercial property, even though some has been sold?

It is possible to 1031 Exchange your interest in an LLC but you should really get paid legal advice from an attorney. Your situation is unique only to you and an attorney can help you structure the agreements so you can 1031 exchange your portion. Qualified Intermediaries are prevented from providing legal or tax advice, the best we can do is provide examples of individuals how have successfully conducted a 1031 Exchange.

Related Info: commercial, owns, interest, advice, legal, attorney, provide, providing, prevented

Does 1031 Exchange apply to selling my primary house?

There are 4 classifications  of Real Estate according to the IRS. The two that qualify for 1031 Exchange are real estate held for investment, usually land AND real estate held for use as a business, usually some sort of rental property. Your personal residence or primary residence or your second home are NOT qualified for the benefits of IRS 1031 Exchange. If you are selling the land around your home, there are opportunities under the mixed classification rules concerning 1031 Exchange. We recommend a discussion with your tax advisor to see if you qualify for this inclusion.

Related Info: house, primary, selling, apply, real, estate, land, residence, usually, home

Where do I report my 1031 Exchange on the IRS Form 1040?

The form to use for reporting your 1031 Exchange to the IRS is the Form 8824. Your CPA or Tax Advisor knows about this form and will be happy to discuss how to fill it out with you. The form is available from the IRS web site at this address. A quick review of this form will help you organize your documents when it is time to file your return.

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How long do I have to keep an investment property for a 1031 exchange?

In a 1031 Exchange the classification, "Real estate held for investment purposes", is almost always land. Land, by itself, and regardless how it is zoned, almost always qualifies for like-kind treatment in a 1031 Exchange. It is the one classification of like-kind that can be exchanged indefinitely. This is because of the nature of why people purchase land, because it will continue to appreciate in value. This means you can 1031 Exchange into a land A today and tomorrow turn around and 1031 Exchange land A for land B tomorrow on the "quick flip". You cannot; however, do this with the other like-kind classification which is "Real estate held for use in a business or trade", such as a rental property. Attempting to "quick flip" a rental property would put you in danger of creating a "dealer property" scenario. Dealer propery, or land held for sale to customers, does not qualify for 1031 Exchange.

Related Info: investment, land, classification, like-kind, dealer, quick, rental

Can a trust holding a property do a 1031 exchange? There are 3 beneficiaries. Can there be 3 separate properties after the exchange?

Trusts can do a 1031 Exchange, we do them all of the time, but like LLC's and LTD's, they have to be executed as a single entity. If the goal is to purchase 3 separate properties for the 3 beneficiaries, we recommend selling the property as a single trust, purchasing the 3 properties as a single trust, then dissolving the trust and splitting the properties/assets among the beneficiaries.

A trust cannot separate the properties among the individuals.

For further information, please review this with your attorney or CPA.

Related Info: properties, beneficiaries, holding, single, among, properties/assets, dissolving

Can i enter a 1031 exchange on my primary residence if i run a trade or business from it?

Great question. Your primary residence is excluded from 1031 Exchange as it is not considered like-kind by the IRS. The fact that you are running your business from it does not matter. Consider the farmer who runs his farm from his home. While the land his farm occupies may qualify for 1031 Exchange, his home, even though he ran the business from his home, does not qualify for 1031 Exchange and must be treated as a straight sale. These are called Mixed Classification exchanges and more information about them can be obtained in our 1031 Exchange Knowledge Base.

Related Info: business, trade, residence, primary, home, qualify, farm, sale, straight

Can I take Earnest Money from my sales proceeds?

No.  Your sales proceeds may ONLY be used to purchase 1031 Exchange replacement properties. The best option is to use your own funds for Earnest Money deposits and then get these back at the time of closing.

Related Info: proceeds, sales, money, earnest, deposits, time, closing, funds

Can I 1031 Exchange my Rental Unit and apply any of the proceeds to my personal residence?

No. There are a couple of issues here. In order to qualify for 1031 Exchange treatment there MUST BE AN EXCHANGE of properties. This won't happen since you are the owner of the rental property and the personal residence. Also, usage of the proceeds must for a like-kind property. A personal residence is not a like-kind property and real estate held for personal use does not quality for 1031 Exchange Treatment.

Related Info: personal, residence, proceeds, apply, unit, rental, like-kind, treatment, quality, usage

You mean I can 1031 Exchange a house for a duplex, triplex, etc?

It depends. You have to remember that a qualified 1031 Exchange must be of like-kind real estate. The only 2 kinds of real estate that qualify for IRS 1031 Exchange is Real Estate held for investment purposes, such as land AND Real Estate being used as a Business, including duplexes, triplexes, etc.

Related Info: triplex, duplex, house, real, estate, business, including, duplexes, land

What the heck is the 1031 exchange "napkin test?"

Old time 1031 Exchange gurus use the term "napkin test" to describe the basic rule that all cash proceeds from the sale of the Relinquished Property must be “reinvested” in the Replacement Property to avoid recognized taxable gain from the exchange. If you trade up, and all the cash is “reinvested”, no taxable boot. But if you trade down, and all the cash is not “reinvested”, the net cash back to you is treated as cash boot received and recognized as taxable gain.

However, there is an adjustment to cash boot received not realized by many when the exchange is originated and in the planning stages. Selling expenses paid in connection with a §1031 exchange are treated as cash boot paid and offsets any boot received. Selling expenses include brokerage commissions and other closing costs such as title policy fees, escrow fees, and recording fees. This means you can trade down by the amount of your selling expenses paid and still have no recognized gain. Here is an example of this vital tax-planning tool.

You sell your Relinquished Property and the cash proceeds total $135,000. Your selling expenses total $32,000 of which you paid $10,000 outside of escrow. The balance of the selling expenses or $22,000 was paid through escrow and the net proceeds of $113,000 are paid into your QI’s trust account. At this point, your net cash boot received is $103,000 and this is the amount you need to “reinvest” to avoid net boot received and taxable income.

Selling Expenses are all expenses directly related to the sale of the Relinquished Property and is the amount used by IRS to deduct from the Selling Price to figure the Adjusted Sales Price. Selling expenses do not include interest, points, taxes, fixing up expenses, repairs, insurance, operating expenses of the property, personal bills or impound account adjustments. Occasionally selling expenses are paid outside of escrow. For example, a consulting fee paid in connection with the transaction may qualify as a selling expense. Be sure to check with your tax professional if you have any questions regarding your particular selling expenses. See Chapter Four for more discussion of this important topic.

Related Info: test, napkin, heck, expenses, selling, cash, paid, boot, taxable

We are considering selling our portrait photography studio with about one acre of land. We want to know if we can use the 1031 exchange rule to use the money that would be taxed to reinvest into rental property.

Hi Elaine! 1031 Exchange properties are those considered a like-kind by the IRS. This includes business real estate and land. So if you are selling a portrait studio, if the business owns the building and the land that it occupies, you may sell it and exchange for a rental property. However, it should be noted that you cannot sell the business itself in exchange for real estate. This will not work. The like-kind rule covers the equipment in a business, though it must be exchanged for like-kind business equipment, ie computers for computers, desk chairs for desk chairs, etc.

Related Info: money, rule, taxed, reinvest, rental, land, business, like-kind, equipment, computers, estate

Before I 1031 Exchange a property, can I borrow against it?

An interesting concept, this is called anticipatory mortgaging and has some benefits for a 1031 Exchange. What if you were to refinance your Relinquished Property prior to the exchange to get cash and then raise the mortgage to be assumed or paid off by the buyer? Remember these things:

Borrowing money on your property is not a taxable event so it won't affect your 1031 Exchange.
The higher mortgage increases the amount of mortgage boot received that qualifies for offsetting against mortgage boot paid.

Let's say Davis wants to exchange Cloverleaf Apartments for Sunshine Apartments owned by Roberts. The terms of his exchange include:

Davis assumes a mortgage of $274,000 on the property he acquires in the exchange.
Davis has a mortgage on Cloverleaf of  $100,000 that will be assumed by Roberts.
Based on the market values of the properties, Davis receives cash boot in the amount $200,000 to balance the equities.
When the exchange is closed, Davis receives taxable boot in the amount of $200,000 making him very unhappy.
Here’s how his taxable boot is figured following the offset rules of 1031:
Mortgage on Cloverleaf Property relinquished was $100,000 (mortgage boot received)
Deduct mortgage on Brentwood assumed by Jones - $274,000 (mortgage boot paid)
This results in a negative offset - $174,000
However, under the rules, mortgage offset cannot be less than zero. Davis gets no boot offset from the difference of $174,000 to offset his cash boot received of $200,000. The result is Davis gets hammered for a $200,000 taxable gain.

Experienced 1031 exchangers are quick to recognize transactions where negative boot relief can result in more gain being recognized from net boot received. In our example, Davis should consider borrowing on his Relinquished Property (Cloverleaf) prior to and outside the exchange transaction. If he refinanced and took out $175,000 cash (non-taxable), his boot would be figured like this:

Davis assumes a mortgage of $274,000 on the property he acquires in the exchange.
Davis has a mortgage on Cloverleaf of  $275,000 that will be assumed by Roberts.
To balance the equities, Davis receives cash boot in the amount $25,000.
When the exchange is closed, Davis receives taxable boot in the amount of only $26,000 making him very happy. Here’s how the taxable boot for this exchange is figured following the offset rules of 1031:
Mortgage on Cloverleaf Property relinquished was $275,000
Deduct mortgage on Sunshine assumed by Davis - $274,000
Difference – Mortgage relief boot received by Davis is $1,000
Add Cash boot received of $25,000
Total boot received by Davis is $26,000
By refinancing outside the exchange, Davis reduces his gain $200,000 to only $26,000.

Exchangers should seriously consider some financing moves outside the exchange to reduce the negative boot relief to zero if possible. Even though equities would not change, the amount of taxable boot could be substantially reduced. This can be accomplished but only with very careful and knowledgeable planning. You don’t want any financing moves treated by the IRS as part of the exchange transaction.

If the refinancing can be demonstrated to be unrelated to the exchange of the Relinquished Property, the proceeds of the refinancing will not be characterized as boot.

The IRS issued a Proposed Regulation making such mortgage proceeds taxable but it was not adopted.

Replacement Property may be refinanced after the exchange is closed and the proceeds used by the owner for any purpose. This is a non-taxable event. However, to qualify, the refinancing must not be connected to the exchange transaction such as a contingency for the exchange to close. The exchange agreement and closing statements should be silent regarding the refinancing.

Related Info: , boot, mortgage, davis, taxable, offset, cloverleaf

My father is selling his farm and purchasing another one out of state. He wants to add my name to the new purchase when he does the 1031 exchange. My name was never on the current property. Can he do this at the time of the exchange or does he has to wait a certain amount of time?

You cannot change the title names during a 1031 Exchange. Better to Quit Claim Deed AFTER the exchange is completed. Please contact us for 1031 Exchange Qualified Intermediary services. We charge $295 to sell your property and $200 to purchase another.

Related Info: name, time, purchase, current, wants, state, services, $295, $200, completedplease, deed

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