1031 Exchange FAQ
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.
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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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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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Is it too late to do a 1031 Exchange, money is in escrow, haven't signed papers or given up title yet?
If you haven't given up title or signed any papers then you haven't officially closed the sale, even though your buyer has already deposited the funds into Escrow. Because of this, you still have time to convert the sale into a 1031 Exchange. The best and quickest thing to do is contact Realty Exchangers, RIGHT NOW! You may call them at 800-570-1031 or visit their web site at http://www.realtyexchangers.com
. If you already have all of the information together and want to fast-track delivery of your 1031 Exchange documents, visit http://www.realtyexchangers.com/SETUPEXCHANGE.php
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When can I have my 1031 Exchange Proceeds back?
It all depends on whether you have already identified your 1031 exchange replacement properties. If you already have, then you must wait until your 1031 Exchange Period is over before you should collect your money. If you have not yet identified your replacement properties, then you may have your proceeds back, though these would now be subject to Capital Gains tax.
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Can income from a timber deed be used in a 1031 exchange?
Timber is an example of 1031 Exchange like-kind property and may be exchange for other like-kind 1031 exchange property. Review our 1031 Exchange Knowledge Base:
Timberlands differing in quality and quantity of timber.
Timberland, with a reservation of timber cutting rights, for timberland.
Additional reading may be found here http://www.realtyexchangers.com/1031_Exchange_Information_Center/Topic_2_-_Qualified_Property.php#_1Timberlands
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What if I die before I complete a 1031 Exchange?
Though tragic, this does happen. Death and taxes are two facts of life that we all want to avoid. If you die during your 1031 Exchange Period, which is time after your sell your property and before you purchase your last replacement property, there are provisions. Your estate and heirs are giving certain Title Considerations which allow them to complete your 1031 Exchange in the event of your death.
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Can I do an exchange out of an LLC and purchase the replacement property of which I am also a member of another LLC?
Chain of title requirements state that a property must pass from one entity to the same entity on the 1031 exchange property.
If ABC Company, LLC owns a piece of land and sells it for 1031 Exchange, ABC Company LLC must purchase the replacement property as ABC Company LLC. No exceptions. What this means for the shareholders of ABC is that individual partners cannot split out their shares and purchase something else...unless the individual partner names are listed in the title of the property being sold.
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What are the restrictions of using a 1031 Exchange?
First of all the property you are trying to sell and convert into a 1031 Exchange must qualify as like-kind under the IRS's 4 classifications of Real Estate. Of the 4, there are 2 classifications of real estate that qualify for IRS 1031 Exchange. These are:
Property that is held for Investment: This is almost always some form of land. Zoning of the land does not matter. You can sell Farm Land for a land lot in a city, Land is land and is almost always considered like-kind.
Property held for a Business or Trade: This type of real estate is property that is earning an income as a business, such as an apartment or business complex or a rental home. Sometimes vacation homes can qualify IF they are rented out for a significant portion of the year and are never considered as you primary residence.
Both of these types of real estate are inter-changeable, meaning both are considered as like-kind. This means you can 1031 Exchange a piece of land for a rental home. You can 1031 Exchange an apartment complex for a parcel of land. Land that has a primary residence or an apartment complex that has a primary residence as considered Mixed Classifications and have a different set rules.
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Can I 1031 Exchange two rental condos for two commercial rental building? These are still like-kind, right?
YES for this 1031 exchange - all properties you described will qualify. Even though these properties may seem different, they are both considered like-kind and therefore qualify for capital gains deferred under the IRS 1031 Exchange rules.
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In a 1031 Exchange, what if the owner occupies one of the units of a 4-plex? Restrictions?
Remember, that a 1031 Exchange is for like-kind property. The dwelling that the owner occupies,regardless of whether it's a home or an apartment, is not considered like-kind with the rest of the unit in the complex, it's considered real estate held for personal use, which has a different tax provision. What we are discussing here is what is called a Mixed Classification and if there is an exchange of the entire property, the personal dwelling becomes boot, which is subject to Capital Gains tax with no deferment.
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What is Substituted Basis?
Before you enter into any 1031 exchange of your real estate, you should figure the basis of the Replacement Property you are acquiring and see how it fits in with your financial and tax plans.
The rules for figuring basis for property acquired in a tax-free exchange take into account the gain is not forgiven, but “postponed” This is accomplished by providing a “substituted basis” for the property received. The basis of your Relinquished Property exchanged without recognition of gain becomes the basis of your new property. Your old basis is “substituted” into the new property. Someday, if you dispose of the new property, the previously unrecognized gain (or loss) might be subject to tax.
Basis is used as the base point for the calculation of capital gain on a transaction. Capital gain is described as the difference between the basis and the adjusted sales price of a property.
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Can you split a 1031 Exchange?
IRS 1031 Exchange is a vehicle tax-payers have used for 20 years to defer their capital gains tax by selling qualified, like-kind investment or business property. 1031 Exchange have been executed by single and married tax payers, businesses and partnerships, LLC's, Trusts, TIC's and Corporations. In order for there to be an exchange, the name on the title for the property you are selling, should remain the same for the properties you are purchasing. Changing Title or "splitting" the title out, will create issues with the IRS when it comes to determine who conducted the 1031 Exchange. Better to keep the title the same all the way through. If you hold property as a partnership or business, it is also possible to "split" up the partnership with a 1031 Exchange. Depending on how the properties are deeded, partner A can purchase one property as a replacement property, while another partner B can purchase 3 other properties separate from partner A. More information about splitting up a partnership with a 1031 Exchange can be read by clicking here.
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In my 1031 Exchange, do I have to purchase 3 replacement properties?
You have three purchasing options when it comes to your 1031 Exchange Replacement Properties. By far the most popular option is the 3 property rule, which means that you may purchase up to 3 replacement properties without regard to the fair market value of these properties. Naturally, if you purchase 3 properties that are valued higher that your 1031 Exchange proceeds, you will have to make up the difference out of your own pocket. And no, you do not have to purchase exactly 3 properties, you may purchase 1 or 2 properties without penalty. Purchasing more than 3 properties, would lead you to decide to use one of the other Replacement Property options, such as the 200% rule or the 95% rule.
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What does a 1031 exchange transaction mean in real estate?
When Realtors are talking about someone who is doing a 1031 Exchange or are referring to a 1031 Exchange, they may talk about it as a 1031 Exchange transaction. Often the 1031 Exchange transaction refers to what happens at the closing of sale in that the proceeds are immediately moved from Escrow into a 1031 Exchange Qualified Intermediary's Client Trust Account. There is no difference in terminology between a 1031 Exchange and a 1031 Exchange Transaction, they mean the same thing. Do not be confused by these terms.
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Can I get a 1031 Exchange Extension in California?
The only extension that is available for 1031 Exchange in California, or any state for that matter, is the extension that you can request if your 180 day deadline falls after your April tax filing deadline. There are no other extensions available 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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How do I use 1031 Exchange to split up a partnership?
1031 exchange is an excellent vehicle for “splitting-up” two (or more) co-owners.
Let's say you and I both own a rental property as co-owners that we will call the Skyline Apartments. From some reason you want out but I am not willing to give up my interest. If I buy you out, you have a big taxable gain. You don't want this.
So, you find another rental you want to buy. I buy the property and swap it for your 50% tenant in common interest in Skyline. The result is you get your entire equity out of Skyline with no recognized gain and I end up with 100% ownership interest in Skyline.
This can also work to take out a 25% owner, 10% owner and so on.
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Can I 1031 Exchange an investment property and use the proceeds to reduce the principal of another investment property?
You must have an exchange of qualifying 1031 Exchange properties in order to make this work. The question you describe doesn't sound like you are purchasing a like-kind property. So, in this case the answer is no. However, if you intend to purchase the other investment property, then Yes, perhaps you can have a 1031 Exchange. Better to call us at 800-570-1031 and explain your exact situation.
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My biggest worry about doing a 1031 Exchange is the 45 day deadline. Help?
Yes, you have 45 days to identify Replacement Properties once you convert your sale into a 1031 Exchange. You are right that doesn't seem like a lot of time. We encourage to you find a local 1031 Exchange Real Estate Professional who can help you find some qualified replacements. Careful planning before you sell your property is not out of the question. Many people already have replacement properties in mind before they sell but if you do not a great place to look in on-line. Try the Exchangers Clearinghouse, our national 1031 Exchange Property Search Engine, it's free! We have new listings being added daily, so check back often.
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Can I 1031 Exchange a property that I've owned for less than a year?
This question usually comes from people who have bought a rental house and want to know how soon before they can 1031 Exchange it again, or someone has purchased some land and wants to know the same thing. First of all, when you want to sell a like-kind property, the only protection you have from it being considered a Dealer Property (property primarily for sale to customers) is time. The longer you hold a property the better chance you have of selling it as a 1031 Exchange. So that rental house you purchased can be considered a Dealer Property if you try to sell it as a 1031 Exchange for less than a year. As a rule of thumb, to prevent being classified a dealer property, it is best to hold your rental house for at least 2 tax periods and collects during that time.
The other like-kind classification pertains to land, or real estate held for investment purposes. It is much easier to 1031 Exchange land that you have held for less than a year because land is always purchased with the intent that it will appreciate in value. So, you could 1031 Exchange your land for a like-kind property after holding it for less than a year.
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What does 1031 Exchange Incidental Property Mean?
When you are involved in a 1031 Exchange often you may end up exchanging other non-real estate property as well, such as furniture, appliances, computers, etc.
When it comes time to identify this property within the 45-day identification period, it should be noted that property which is incidental to Real Estate property, such as furniture, laundry machines, appliances, pumps, etc. is not treated as separate property from the real estate property if:
In standard commercial transactions the property is typically transferred together with the real estate property, and;
The aggregate market value of the incidental property does not exceed 15% of the market value of the real estate property.
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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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Can land that is held in an irrevocable trust qualify for a 1031 exchange?
Even if the buyer's money would be put into a trust and the trustees would assume the trusteeship of the other's trust and the beneficiaries of each trust would be swapped. There is not much we can do for you with a 1031 Exchange. The biggest problem with trusts, is that they get involved in so many legal issues. And since there are so many different kinds of trusts, with so many unique variations, it is very difficult to answer you question without knowing all of the details of your particular case. Since we are barred from providing legal advice, we recommend you discuss this with your attorney or the trust's attorney.
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Does the 1031 exchange have to be included in the purchase agreement?
Normally, in a 1031 Exchange, we encourage tax payers to use the following clause in their Purchase and Sale Agreements.
"Buyer hereby acknowledges it is the intention of Sellers to complete a deferred exchange and qualify for treatment under Internal Revenue Code Section 1031. This exchange will not delay the closing (of escrow) or cause additional expense to Buyer. Seller's rights and obligations under this agreement may be assigned to a Qualified Intermediary (as defined in IRS Regulation 1.1031(k)-1) of Seller's choice for the purpose of completing the exchange. Buyer agrees to cooperate with Seller and the Qualified Intermediary in a manner necessary to complete this exchange."
However, in situations where time is of the essence a suggested clause that the deal is a 1031 Exchange doesn't necessarily have to be included in the purchase and sale agreement. The Seller providing the Closing company with the documents necessary to convert the sale to an exchange (these are supplied by the Qualified Intermediary) is sufficient.
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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.
Any Replacement Property received by you before the end of the identification period is treated as being properly identified under the Identification Rules.
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In a 1031 Exchange, what happens if both parties have mortgages?
In a 1031 exchange, you are in effect, swapping your mortgaged property for their mortgaged property. Also, the assumption of a liability by the other party (or transfer of your property subject to a liability) is treated as boot received by you. It's called mortgage relief. In figuring your net mortgage relief, you may offset against it your assumption of a liability (or transfer of property subject to a liability).
The assumption of a liability or the transfer of a property subject to a liability is treated as boot.
If the other party assumes your liability—or your property transferred subject to the liability—you have received boot. You will be treated as if you received cash in the amount of the liability. The party assuming the liability, or acquiring the property subject to the liability, gives boot.
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Can I 1031 Exchange into a home that has a lease with an option to buy?
One of the factors that disqualifies 1031 Exchange property is when it is held primarily for sale. Most people associate these properties as those held by dealers.
But be aware that "held primarily for sale" is not limited to strictly to dealers. Property was deemed held primarily for sale and not for investment where it was sold under a “prearranged plan” shortly after it was acquired in an exchange.
What this means is that property acquired in an exchange and leased with option to buy is not held for use in business or for investment which disqualifies it for 1031 Exchange.
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In a 1031 Exchange, how do you define a personal residence?
Section 1031 Exchange and the related regulations make it very clear that real estate held for personal use cannot qualify for 1031 exchange treatment. But sometimes the residence gets involved in an exchange and it can get complicated.
The term primary residence refers to the place in which you principally reside. If you have more than one home, only your principal home qualifies as your primary residence.
Your primary residence includes the dwelling unit and the land it's located on. The land alone, however, is not a residence. If part of the land is sold, but not the dwelling unit, the land sold is not treated as the sale of a residence.
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1031 Exchange Who? What? When? Where? Why? How?
The Who, What, Where, When, Why and How of a 1031 Exchange can be found here!
1031 Exchange - Who?
1031 Exchange - What?
1031 Exchange - Where?
1031 Exchange - When?
1031 Exchange - Why?
1031 Exchange - How?
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