1031 Exchange FAQ
Can I 1031 Exchange a rental home with my sister?
Yes, you can, as exchanging with a related party is OK - but to qualify for a 1031 Exchange, you should understand exactly what an exchange with a related party really means and the rules for making it work.
You have two kinds of exchanges involving related parties available to you. One is a direct swap between related parties. The other is an exchange involving a sale of the Relinquished Property and the acquisition of a related parties property.
Direct swaps may qualify for a 1031 but a special 2-year rule applies that could result in triggering the gain when you least expect it. This rule affects all like-kind exchanges between related parties including reverse exchanges. Under this rule if you or the related party disposes of the property within 2 years after the exchange, the exchange is disqualified and gain or loss will be recognized for both you and the related party as of the original date of the exchange.
Some of these exchanges are not subject to this rule.
You are the owner of a property you want to sell. Your daughter owns the property you wish to acquire. She is not interested in your property but is willing to sell her property. You find a buyer for your property (Relinquished Property) but before closing the transaction enter into an exchange agreement with your Qualified Intermediary. As part of the exchange, you purchase your daughter’s property as your Replacement Property. Since you are the only party qualifying for §1031 exchange treatment, the exchange is not subject to the 2-year rule. Daughter has a taxable sale.
As always discuss this with you tax preparer for the best course of action.
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Can a partnership interest sell a property at a loss and still get 1031 Exchange treatment?
Partnership interests are specifically excluded as qualified property under 1031 Exchange rules. However, it is possible in many situations to design a transaction to accomplish the goal of an investor to get out of the partnership and still qualify for 1031 treatment Exchange Treatment.
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 seek to execute a §1031 exchange.
Caution: This procedure can be risky but if the savings are substantial, it’s worth checking out with counsel.
A very common situation is the single property held by two “partners.” Many joint owners of a rental income property consider themselves as partners when in fact they are tenants in common. In general, a partnership is formed when two or more persons (includes corporations) join together to conduct a business activity with the intent of sharing profits and losses. However, mere co-ownership of real estate maintained and leased or rented is not a partnership unless the co-owners provide services to the tenants other than the normal landlord activities.
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What if no depreciation recapture was taken on my 1031 exchange property?
Depreciation recapture is a factor that must be considered when you determine your capital gains tax and if you are considering an IRS 1031 Exchange. You add it the 15% tax on your Net Realized Gain (Adjusted sales price minus Adjusted Basis). If you have taken NO depreciation during the time you owned your property, your Depreciation Recapture would be ZERO and you would just use the 15% tax on your Net Realized Gain to determine your Capital Gains Tax. Check it out for yourself on our FREE Capital Gain Tax Estimator, by clicking here.
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How many replacement properties can I have?
There are 3 rules:
The one most people use is the 3-Property Rule because they can identify 3 1031 Exchange Replacement Properties without regard to fair market values of the properties. You figure fair market value of Replacement Property as of the end of the identification period.
The next rule is the 200 percent rule which allows you to 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 Relinquished Properties as of the date you transfer them.
The final rule is the 95 percent rule which allows you to 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.
Beware of the 200 percent rule and the 95 percent rule. If you are choosing to follow these rules, we suggest you get help from your CPA or Tax Attorney. If they are not conducted properly as of the end of the identification period and you have identified more properties as replacement properties than permitted, you are treated as if no Replacement Property has been identified. Which means the IRS could decide that no 1031 Exchange occurred and you would end up paying the capital gains tax.
This is why most people follow the 3 property rule, it is easiest to understand with lessor risk.
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In a 1031 Exchange, Is Boot Taxable, even at a loss?
Yes and no.
In a 1031 Exchange, if you receive no cash or property boot in the exchange, but you have net mortgage relief, you may offset sales expenses paid against your net mortgage relief. If the offset creates a “loss”, the Code bars any deduction.
You should also remember that your Loss is not deductable.
However, if the sale of the personal property had resulted in a loss, the loss would be deductible as an ordinary loss since the nonrecognition of gain or loss provision of §1031 does not apply to unlike property.
The gain or loss is the difference between your adjusted basis in the property and your amount realized. The fair market value is considered to be your amount realized.
For example, as part of an exchange you give unlike property with a cost of $1,000. The fair market value of the property at the time of the exchange is $1,500. You will recognize a $500 gain.
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How long must rental be held before I can 1031 Exchange it?
Whether you are decided to 1031 Exchange your rental property for something else, OR you want to purchase a rental property with a 1031 Exchange, it is important to figure out and understand if the rental truly is a rental. Of the 4 classifications of Real Estate, the distinction between Real Estate Held of a Business or Trade AND Real Estate Held for sale to customers (dealer property) can be a foggy one. If you are intending to sell a rental property or purchase one you need to show intent of the purchase. If you are selling, you must show that you have collected rents from the property for at least 2 tax periods. If you are buy, the seller must show that they have collected rents for 2 tax periods. Anything less than 2 tax periods could be construed that the intent was to selling the property on the "quick flip". This could change the classification of the rental to a dealer property, much disqualifies it for 1031 Exchange.
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Why are the 1031 Exchange selling expenses deducted?
Many real estate agents and investors when working out the numbers for their 1031 exchange often overlook selling expenses as an offset against boot received. Factoring in this offset is critical 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.
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1031 Exchange seems complicated. Is it?
Like a lot of things in life, it's only as complicated as you make it. In fact, the rules for 1031 exchange are actually quite simple. Owners of qualified 1031 Exchange properties, either investment real estate or business real estate, can defer the capital gains tax from a sale by exchanging their property for a like-kind property. The proceeds from the sale must be kept with a Qualified Intermediary.
What makes this difficult is the fact that some individuals try to circumvent the IRS's section 1031 Exchange rules by either trying to 1031 exchange a property that doesn't qualify or trying to tamper with their sale proceeds. The easiest and simplest way to conduct a 1031 Exchange is to understand the rules and keep your 1031 Exchange easy and simple.
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What is a 1031 Exchange Disqualified person?
The exchanger or a disqualified person cannot qualify as qualified intermediaries for their own 1031 exchange. A person is a disqualified person if:
The person is an agent of the exchanger at the time of the transaction.
The person and the exchanger bear a relationship described in Section 267(b) or Section 707(b). However, you must substitute “10 percent” for “50 percent” each time it appears in those Sections.
The person and a person who is an agent of the Exchanger at the time of the transaction bear a relationship described in (2) above.
These people are treated as agents of the exchanger: A person who has acted as the exchanger’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the 2-year period ending on the date of the transfer of the first of the relinquished properties. However, the regulation disregards certain services for purposes of determining if an agency relationship exists. Performance of services with respect to exchanges of real estate intended to qualify under §1031 is not taken into account.
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Can I 1031 Exchange Property I purchased from a 1031 Exchange 4 years ago?
Good question. To 1031 Exchange any property, you need to consider a few things. First, what kind of real estate is the property we are talking about? If it's land, the answer is almost always going to be yes because land is always considered real estate held for investment purposes. If the property is an apartment building which you have been actively collecting rents from, the yes, the property qualifies for 1031 Exchange. However, if this property is a rental home that you converted into your primary residence then the answer is no because you changed the classification of the property and property that is your primary residence does not qualify for 1031 Exchange.
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In a 1031 Exchange, what is the difference between land held for sale and land held for investment?
When you purchase land, it is difficult to prove that you purchased it with the intent to sell it, as the nature of a land purchase is to hold it for investment because most all land will continue to go up in value. In a 1031 Exchange, the two types of Real Estate that qualify for tax deferment is Real Estate held for investment or Real Estate held for a business or trade, as these types of property are considered like-kind, according to the IRS. Perhaps you have heard of the term, property held for sale. Don't confuse this term for land. Typically, property held for sale (or dealer property), refers to property purchased with the intent to "flip" for a quick buck. The IRS has taken steps to prevent these type of property from 1031 Exchange and they shouldn't be confused with land.
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I sold a property last month, is it too late to 1031 Exchange it now?
Hi, I am interested in determining if I can qualify for a 1031. I sold a property on Sept 22, 2011. I did deposit the cash into my bank account. I am now bidding on another property and could close before the end of the month. The properties are both investment properties. Can I still qualify? Can you assist me in the transaction? Thank you.
1031 Exchange must happen at the time of closing. Because your property has already closed, you now have access to the funds, this means you cannot 1031 Exchange. However, there are times when you have closed sale on a property but the money is still in escrow and out of your control. If that is the case, there may still be time to setup a 1031 Exchange. Check out http://www.realtyexchangers.com
for more information.
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Are 1031 exchanges exempt from the 3.8% real estate gains (medicare) sales tax that begins in in 2013?
The 3.8% real estate gains sales tax is applicable for real estate transactions where the gain is over $250k. The gain up to and including $250k is not subject to the new tax. This tax is not the same as the capital gains tax where the 1031 Exchange is meant to "defer" your capital gains tax until a different time. If you are conducting a 1031 Exchange and are moving your equity into another 1031 property, your liability would be deferred as there would be no gain to tax.
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What qualifies as Real Estate held for investment?
Real Estate held for investment is one of the 4 classifications of Real Estate that the IRS has said qualifies for 1031 Exchange. Typically, this almost always land. Investment real estate is a capital asset (IRC Section 1221). It's property held primarily for appreciation of value due to location, passage of time and other factors outside the activities of the owner. It is treated as a portfolio investment asset. Even if purchased with the idea you might someday develop the property, if you don't develop it (for any reason), the property will not lose its classification as investment property.
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In a 1031 Exchange, when is boot not taxable?
Nearly all boot is taxable. Many taxpayers forget that all of the costs that went in to selling your 1031 Exchange property are offset against any of the boot that you have received. If you have $10k in boot but it cost $11k to sell your property, you would have boot but none of it would be taxable because the $11k to sell your property would be written off. More reading about Boot can be found here!
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My Realtor told me I should avoid using a Qualified Intermediary for my 1031 Exchange. Please Explain?
Interesting, though not surprising. There are a number of professionals, including some mis-informed Realtors, in the Real Estate industry who fail to understand how a 1031 Exchange works or how easy they are to execute. True recent news does include reports of Qualified Intermediaries with unsafe funding practices, but most QI's are solid companies with impeccable reputations. Your question leads to explaining why a Qualified Intermediary is necessary? A Qualified Intermediary is a necessary function of the 1031 Exchange because using one prevents you from being in Constructive Receipt of your proceeds. The IRS has said that at no time during the 1031 Exchange period may you have direct access to your sales proceeds. This measure is mean to insure that ALL of the funds are spend on the 1031 Exchange at not used for other purposes. Also, it should be understood that any funds removed from the sales proceeds are 100% taxable as Capital Gains and due during the same year of the sale.
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Can I 1031 Exchange a property with my husband?
This is from our 1031 Exchange Knowledge Base article regarding transfers between spouses.
"No gain or loss is recognized on a transfer of property from an individual to a spouse. If the transfer is incident to a divorce, no gain or loss is recognized on a transfer of property to a former spouse. There is no gain or loss even if the transfer is in exchange for the release of marital right or for other considerations or the transferred property is subject to liabilities that are more than the property's adjusted basis and it was not transferred in trust.
Any transfer of property to a spouse or former spouse not subject to gain or loss is treated as a gift and is not considered a sale or exchange. There are no gift taxes if the transfer is made within a certain three-year period. This period starts two years before the divorce and ends one year after the divorce—a total of three years. If the transfer is made at any other time, it is subject to the gift tax. However a transfer under a property settlement agreed on before the divorce, and approved more than two years later by a divorce court, is subject to the gift tax."
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Who regulates 1031 Exchange Qualified Intermediaries?
There is no federal body that regulates 1031 Exchange Qualified Intermediaries. Many of the states are requiring licensing in their state. Washington State requires that 1031 Exchange Qualified Intermediaries are managed by either a CPA or an Attorney. The Federation of Exchange Accommodators is a national organization of Exchange Professionals who have tried to put into place federal guidelines for regulation and education of Exchange professionals. Realty Exchangers, is licensed, bonded and insured in Washington State and a CPA and attorney are officers of the company.
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How do I find a Realtor in my area that can handle 1031 Exchange?
So you closed sale on your Relinquished Property and you're ready for the next phase of your 1031 Exchange, which is FINDING REPLACEMENT PROPERTIES. First, make sure you visit our 1031 Exchange Replacement Search Engine, located at http://www.exchangersclearinghouse.com
, then the next step is use our 1031 Professionals Directory located at http://www.realtyexchangers.com/1031_Exchange/index.html
and find a Realtor who can help you find just the right Replacement Properties. Each and every Realtor on this list is a seasoned-pro with 1031 Exchanges. We've worked with them and can vouch for their knowledge and expertise.
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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.
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What does "like property" mean in a 1031 exchange?
For some of the readers, this may seem a very simple question, of which many already know the answer. However, as more and more taxpayers seek information about 1031 Exchange, this question continues to be asked. So what "like property"? The term "like property" refers to "like-kind" property which is term used by the IRS to describe the types of real estate that can receive capital gains tax deferment using section 1031 Exchange. IRS classifies real estate into 4 classifications, of which only 2 may be used for 1031 Exchange. These are "real estate held for investment" (land) and "real estate held as a business or trade" (a rental home). Many taxpayers are surprised to hear the land and be traded as like-kind with an apartment building under these definitions. It is true and taxpayers have been taking advantage of this for 20 years!
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I own property in Puerto Rico and want to 1031 Exchange it for property in Wisconsin. Can I do a 1031 Exchange this way?
The location of properties being exchanged is very important. Real property located outside the United States does not qualify as a 1031 Exchange property if exchanged for real property located in the United States. In the US, real property means property located within the fifty states and the District of Columbia. Property located in Guam, Puerto Rico, and U.S. possessions are treated as foreign real estate and do not qualify.
However, real estate located in the U.S. Virgin Islands may qualify for §1031 treatment when traded for U.S. real estate. Please see your CPA or attorney for more information in your particular case!
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Why is a 1031 Exchange called boot?
A 1031 Exchange is the continuation of your property investment when you exchange like-kind properties for the purpose of deferring your Capital Gains Tax to a future sale. Boot is the cash or non like-kind property portion in a 1031 Exchange. 1031 Exchange is not called boot, though there are portions of a 1031 Exchange that are considered boot. Remember, that receiving boot in a 1031 Exchange is a taxable event, subject to Capital Gains or ordinary income.
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What kind of liability is treated as boot in a 1031 Exchange?
How do I find 1031 Exchange Replacement Properties?
Answer: Often Exchangers already have their 1031 Exchange Replacement property lined up before they close on their Relinquished Property. For those who don't, there are many resources on-line for finding a replacement property. Our 1031 Exchange web site at realtyexchangers.com has a couple of really good resources available to you.
First. Check out our list of 1031 professionals from every major US city in every state! Shopping for Realtors? This is where to look. There are probably many 1031 pros available in your area, RIGHT NOW. Visit our 1031 Exchange Professionals Directory today!
Second. When we first launched our web site over 15 years ago, we were the first to offer a comprehensive search engine for finding 1031 Exchange replacement properties. It was called the Exchanger's Clearinghouse and it was extremely popular among 1031 Exchangers. When we relaunched our web site last Summer, the Exchanger's Clearing house was relaunched as well. Though still new, it is fast becoming a resource of for 1031 Exchange properties. Listing your properties is always FREE and we have "Haves" and "Wants" lists. Visit the new Exchanger's Clearinghouse today!
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Can a Realtor help with a 1031 Exchange?
Absolutely! Large or small, regardless of the property you are trying to sell, a Realtor is a professional whose goal is to help you maximize your profit while minimizing your delay. When it comes to a difficult, confusing or demanding 1031 Exchange, Realtors are prepared to help you through it! Choosing a Realtor is often difficult, especially when you have choosen a 1031 Exchange Replacement Property an area that you are not familiar with. The best place to search for a qualified 1031 Exchange Realtor is the 1031 Exchange Professionals Directory. Here will find seasoned Real Estate pros who know how to help you sell your 1031 exchange property and purchase the best Replacement properties for your buck.
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Can I 1031 Exchange my interest in a business for interest in another business?
Partnership interests are specifically excluded from 1031 exchange treatment. A partner's exchange of an interest in one partnership for another partner's interest in a different partnership does not qualify for 1031 exchange. However, please note that this IRS rule does not apply to exchanges of interests in the same partnership.
You should also know that a partnership as a business entity can qualify to exchange real estate it owns for other real estate.
For example: A limited partnership owned land and an office building leased under a long-term lease. The limited partnership wanted to dispose of the land and building and acquire several parcels of real estate. It located someone interested in buying the land and building. The limited partnership proposed to transfer title directly to a Qualified Intermediary and then form separate entities to take title from the QI for each of the replacement properties. The limited partnership would be the sole owner of each "replacement entity.” These entities would then either elect to be disregarded as an entity or would rely on the default classification for single-owner entities.
For discussion of strategy using §1031 to Split Up Partners and Investors in Real Estate see Topic 11.
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Some 1031 companies say “defer”, some say “don’t pay” capital gains tax with a 1031 Exchange. Which is correct?
Answer: When you sell your property and purchase another property with a like-kind property you are conducting an IRS 1031 Exchange. "Defer" or "Don't Pay" is simply marketing language intended to get your to consider a 1031 Exchange if you have property to sell. With a 1031 Exchange the reality is that "some day" you will be paying the capital gains on your property but with a 1031 Exchange you are really "deferring" it to some other time. We have had customers defer their capital gains several times by buying and selling the same piece of land. Since land almost always qualifies, under the 1031 Exchange rules you can do this. The question is with a 1031 Exchange are you saying that you will "never" pay your capital gains tax. In our 20 plus year experience with the US Internal Revenue Service we learned to "never say never".
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Can a non-profit organization perform a 1031 Exchange?
Your best bet is to review the real estate holdings of the non-profit and determine who actually owns them. Once you determine ownership, figure out if the properties qualify for 1031 Exchange by viewing the section on Qualified 1031 Exchange Property in our 1031 Exchange Information Center. Next, talk to a CPA and find out whether the sale is going to be a taxable event. If the answer is yes, then a 1031 Exchange is an option. 1031 Exchange is available to all taxpayers, regardless of whether they are individuals, businesses, partnerships, organizations or corporations.
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How do I pay Realtor commissions if I 1031 exchange one property for another?
Just like most property sales that include a closing agent, whether it be a Title/Escrow Company, Attorney or CPA, the commissions that get paid to Realtors are considered part of the closing costs. When you execute a 1031 Exchange all of the fees that are incurred for the property sale including, the title insurance, deed, broker's fees, state fees, tax, qualified intermediary fees, outstanding mortgages, liens and whatever else needs to be settled at the close of sale are paid from the gross sale proceeds. Once all of the debts are paid, the remaining net proceeds become the proceeds that can then be used to purchase your 1031 Exchange Replacement Properties.
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