1031 Exchange FAQ

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Common 1031 Exchange Questions

Can I 1031 Exchange my interest in a business for interest in another business?

I'm a Realtor and have clients who want to do a 1031 Exchange, what do I do?

In a 1031 Exchange, do I adjust the sales price to a buyer who gave me 'option money'?

Can I 1031 Exchange water rights to my property for some farmland?

Can I 1031 Exchange a property with my husband?

My realtor told me that I am not a loud to use any of my proceeds before I purchase a Replacement Property. Is this true?

When you close sale on your Relinquished property the proceeds need to be kept in a safe harbor with a Qualified Intermediary (Realty Exchangers). During your exchange period your proceeds can ONLY be used to purchase qualified 1031 Exchange Replacement Properties. Any withdrawal of your funds could negate your 1031 Exchange when the IRS reviews your file.

You have two opportunities to access your proceeds and not jeopardize your exchange.

The first is when you close sale on your Relinquished property. At that time you make take a portion of the proceeds back for your own use. This called Boot Receivable and is subject to Capital Gains Tax. The remaining funds from your sale should be transferred as your proceeds into your Qualified Intermediary's (Realty Exchangers) client trust account.

The second is after you have closed sale on all of your Identified Replacement Properties before the 180 day deadline. These left-over proceeds are also subject to capital gains tax.

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How do I identify a 1031 Exchange Property?

A Replacement Property is considered identified before the end of the 1031 Exchange 45-day identification period only if the following requirements are satisfied. However, any Replacement Property you receive before the end of the identification period will in all events be treated as identified before the end of the identification period.

A Replacement Property is identified only if it is designated as Replacement Property in a written document signed by you. This document must be hand delivered, mailed, telecopied or otherwise sent before the end of the identification period to a person (other than yourself or a related party) involved in the exchange.
A Replacement Property is identified only if it is unambiguously described in the written document or agreement. Real estate is unambiguously described if it is described by its legal description or street address. Be sure to be VERY clear in the description of the property. Reviewing the title deed of the property is a great place to start.

Property incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if in standard commercial transactions, the property is typically transferred together with the larger item of property, and the aggregate fair market value of all "incidental" property is not more than 15% of the aggregate fair market value of the larger item of property.

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If my replacement property is a rental how long does it have to remain a rental before it can be converted into my primary residence without losing my §1031 exchange benefits?

There are no hard rules here. Just show IRS your intent to use your replacement property as a rental. Most of tax attorneys we talk to feel that if the property shows up as a rental on two or more consecutive tax returns you will have shown intent.

Related Info: rental, losing, benefits, residence, converted, remain, intent, consecutive, returns, shown, shows


I want to do a 1031 Exchange but don't understand why I cannot hold the funds in my bank?

The secret of a successful 1031 exchange is to avoid holding the money or other property during the transaction. If you receive cash proceeds during your 1031 exchange, you will not qualify for the capital gains deferment. While this sounds easy to avoid, it's not. You must overcome the doctrine of " constructive" receipt. The general rules concerning actual and constructive receipt apply to determine if you are in actual or constructive receipt of money or other property before you actually receive like-kind Replacement Property.

You are also treated as being in receipt if you receive the economic benefit of the money or property. You are in constructive receipt of money or property at the time the money or property is credited to your account, set apart for you, or otherwise made available to you so you may draw upon it at any time. Or if you can draw upon it if notice of intention to withdraw is given. In addition, actual or constructive receipt of money or property by your agent is actual or constructive receipt by you.

The deferred exchange Regulation provides a "safe harbor" that permits you to sell your Relinquished Property and acquire Replacement Property and avoid constructive receipt. This safe harbor is your written contractual agreement with a Qualified Intermediary.

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I sold a property on November 30, 2010 and entered into a 1031 exchange via an accomodator. My tax preparer filed my return on April 15, 2011 prior to my closing, but also filed for an extension. Now that my exchange has completed, can I file an amended return, or is my exchange invalidated? should he not have filed the return, and just the extension?

1031 Exchanges expire 180 days after you sell your property. The exception is when you taxes are due. Tax Time Trumps your 180 expiration ... unless you file for the extension. Since you filed for the extension, you should be able to get the full 180 days of your 1031 Exchange period, regardless of whether your taxes have been filed or not. The best best is to check with your CPA or Attorney as we obviously don't know your specific situation and there may be issues that we couldn't know.

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Can you do a 1031 Exchange in Hawaii?

IRS Section 1.1031 Exchange is a federal tax action that is available taxpayers in all 50 US states, including the islands of Hawaii and the US Virgin Islands. If you wish to 1031 Exchange qualifying like-kind properties held in the state of Hawaii, you may do so as long as you execute your exchange following the specific rules that were laid out by the IRS in 1990 & 1991. Additional information about 1031 Exchange can be found in our FREE 1031 Exchange Procedure Manual. This book will answer just about every question you can think of regarding 1031 Exchange and how to do one.

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Can my 1031 Exchange closing fees be deducted from my boot?

Yes. It is possible to deduct from your boot the costs to market your 1031 Exchange property at the time of closing of sale.

When working out the numbers for their 1031 exchange, many tax-payers, real estate pros and investory, overlook the 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.

Related Info: boot, deducted, fees, closing, expenses, selling, paid, offset


I would like to 1031 Exchange a duplex for a home with a rentable mother-in-law apartment in the basement. Can this be done?

Is the duplex a rental? If so, you could qualify the 1031 Exchange replacement property if it is rental property. Family rentals count under Section 280A. If the home (replacement property) is all used for a rental - no problem. However, if the client plans to occupy the new home and only rent out the basement, an allocation would have to be made between the personal residence portion and the rental portion. Your tax person should do this. This same logic also applies to the duplex.

Related Info: apartment, basement, mother-in-law, rentable, home, duplex, rental, portion, replacement, allocation


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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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.

Related Info: realtor, proceeds, sales, funds, direct, access, period


Will it jeopardize my 1031 Exchange if intent-to-buy papers before my property is sold?

Intent to buy papers are usually not a binding contract which means you can sign them without fear of penalty. You may even decide to make an Earnest Money Deposit just make sure to instruct the closing company to refund you the Earnest Money and NOT to include it in your 1031 Exchange Proceeds. Many taxpayers wishing to 1031 Exchange their property have used this strategy BEFORE they sell their own property, they choose this option rather than risking a reverse exchange. If you are NOT doing a reverse exchange, be careful NOT to take Title on the property before you sell your property though, if this is not structured properly you will have a very difficult time converting your sale to a 1031 after the fact.

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You talk a lot about 1031 exchange of real estate. Can I 1031 other property?

Yes. If you have property held for productive use in a trade or business, or for investment purposes, it may qualify for 1031 Exchange treatment under the IRS Section 1031. Lots of 1031 exchanges involve "multi-assets", which include real property and personal property. Discuss this with your CPA or attorney and see how it applies in your particular case.

Related Info: estate, real, personal, include, multi-assets, discuss, attorney


How does the step up in basis work for my heirs if I die during my 1031 Exchange?

A related taxpayer exchange not disqualified if the disposition of property within the 2-year period following the original 1031 exchange takes place after the date of death of the taxpayer or the date of death of the related person.

A related taxpayer exchange is not disqualified if the disposition of property within the 2-year period following the original exchange if the disposition is made as the result of a compulsory or involuntary conversion of the property received in the original exchange. For this exception to apply, the original exchange had to occur before the threat or imminence of such conversion.

A related taxpayer exchange will not be disqualified if the disposition of property is made within the two year period following the original exchange if the IRS is satisfied that neither the original exchange or the later disposition has federal income tax avoidance as one of its principal purposes.

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Can I 1031 Exchange a piece of land that I own for a commercial building that I'm already occupying for my business?

We want to be sure we understand your question. You own a piece of land and you want to purchase a commercial building that your business currently occupies. If you are planning to do this 1031 exchange as a transaction, the answer is Yes, you can do a 1031 Exchange. However, if you aren't planning a transaction here then the answer is no. For all 1031 Exchanges, there must be a transaction with a purchase and sale agreement and a title transfer.

Related Info: business, occupying, building, commercial, land, transaction, planning, purchase, sale, exchanges, agreement


How do I figure out the adjusted basis on the property I am selling in a 1031 Exchange?

The formula for figuring out your adjusted basis on a property you are selling is:

Original Purchase Price. The amount you originally paid for the property when you bought it.
Plus Capital Improvements. Any major additions or improvements to the property, such as adding a room or garage, etc. But not including maintenance.
Minus Depreciation. The total amount of depreciation you have taken since you bought the property.
Equals Adjusted Basis.

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Can I 1031 Exchange the acreage near my residence?

Real Estate Held for Investment is considered like-kind and qualifies for 1031 Exchange. Your personal residence is considered Real Estate Held for Personal Use and does NOT qualify for 1031 Exchange. The scenario you describe is what is called a Mixed Classification. If all or some of the property you want to sell does not qualify for §1031 treatment, a transfer of that property in an exchange transaction will be treated as a sale of that property and subject to Capital Gains Tax. However, the property that does qualify for 1031 Exchange and an attorney can help you carve out your Purchase and Sale Agreement to reflect this.

Related Info: residence, acreage, qualify, personal, real, estate, sale, capital


How do conservation easements on 1031 Exchange replacement real estate work?

From our 1031 Exchange Knowledge Base:

In LTR 9851039, the Internal Revenue Service ruled the exchange of an agricultural conservation easement for a farm property qualifies as a 1031 exchange. The IRS said a parcel of property was of like-kind when exchanged for a remainder interest in a parcel of property. The parties to the exchange were a trust and a corporation. The corporation had one class of stock. The trust owned most of the shares. The adult son of the trustor owned the rest. The corporation owned a parcel of land that it held as income producing rental property. The trust owned a parcel of property also held as income producing property.

The trust proposed to convey to corporation the property on which its headquarters was located in exchange for a vested remainder interest in the property owned by the corporation. After the exchange, the corporation would continue to use the property it gets in the exchange in its business.

The trust would hold its interest in the property it gets for investment. It would hold it as an income producing property when it ripens into a possessory interest at the end of a seven-year period. The IRS said the term "like-kind" refers to the nature or character of the property, not to its grade or quality. Therefore, certain factors, such as whether the property is improved or unimproved, are not relevant. The IRS said the nature and character of properties exchanged by the trust and corporation would constitute like-kind property. Because the nonpossessory interest would become a possessory interest and therefore, a fee interest, the rights vested in the parties were substantial.

Related Info: estate, work, real, replacement, easements, conservation, interest, corporation, owned, parcel, like-kind, income


What is the difference between capital gain and equity in a 1031 Exchange?

Do not confuse capital gain with equity in your 1031 Exchange. There is no comparison between the two.

Equity is the amount of money you have in your pocket after you have sold the property and paid off all related liabilities and mortgages. As an example lets say you bought a property $30,000 ten years ago, it's free-and-clear and has basis of $20,000.

If you sold that property today for $115,000, and paid out $15,000 in closing costs and commissions, you have equity of $100,000. That's the amount of cash you would get out of the closing. However your capital gain on this property would be the difference between your basis of $20,000 and your adjusted sales price of $100,000, or $80,000.

Result: If you sell instead of doing a §1031 Exchange, you would be obligated to pay a capital gains tax on the entire $80,000.

Example with Mortgage: If you had mortgage of $90,000 on this property, you will need to repay this loan at the time of closing. This results in net cash to you at the closing of only $10,000 ($100,000 less the loan payoff of $90,000). But your capital gain tax would still be $16,000.

It is in this area you must be extremely careful not to trap yourself with a regular sale. You are almost bound to exchange in a case like this unless you have the additional funds to pay the taxes. In larger transactions with larger dollars and leveraging, the situation only gets worse.

Related Info: equity, gain, capital, difference, closing, $100, example


When does a 1031 Exchange transaction get recorded?

You and your CPA report your 1031 Exchange on Form 8824 when you file your taxes. The transactional portion of the 1031 Exchange is treated just like any other sale of real estate. Recording the transaction is the function of whoever facilitated the closing for the sale, usually the Title/Escrow Company but this can also be accomplished by a Mortgage company, attorney or CPA.

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What is Like-Kind Property?

Like-kind 1031 Exchange property is property that qualifies for IRS Section 1031 Exchange. The rules state that the property must be held for business use or property that is held of investment purpose and NOT property that you intend to "flip".

Some examples of like-kind property are:

Improved real estate for unimproved real estate.
A leasehold of a fee with 30 years or more to run for real estate. For this purpose, optional renewal periods may be added to the initial term of the lease. See Sale-Leasebacks as Exchanges in Topic 11.
A fee interest in unimproved land for a fee interest in unimproved property subject to long-term income producing condominium leases.
A perpetual water right treated as real property under local law for a fee interest in land.
Timberlands differing in quality and quantity of timber.
Timberland, with a reservation of timber cutting rights, for timberland.
A remainder interest in farmland for a remainder interest in another parcel of farmland.
Farm land belonging to an incompetent for other farm land, even though the exchange took the form of a cash sale and purchase because it involved an incompetent and local law permitted no exchanges by guardians. [v]

In LTR 9851039, the Internal Revenue Service rules that the exchange of an agricultural conservation easement for a farm property qualifies as a tax-free exchange under Section 1031(a). The IRS said a parcel of property was of like-kind when exchanged for a remainder interest in a parcel of property. The parties to the exchange were a trust and a corporation. The corporation had one class of stock. The trust owned most of the shares. The adult son of the trustor owned the rest. The corporation owned a parcel of land that it held as income producing rental property. The trust owned a parcel of property also held as income producing property.

The trust proposed to convey to corporation the property on which its headquarters was located in exchange for a vested remainder interest in the property owned by the corporation. After the exchange, the corporation would continue to use the property it gets in the exchange in its business.

The trust would hold its interest in the property it gets for investment. It would hold it as an income producing property when it ripens into a possessory interest at the end of a seven-year period. The IRS said the term "like-kind" refers to the nature or character of the property, not to its grade or quality. Therefore, certain factors, such as whether the property is improved or unimproved, are not relevant. The IRS said the nature and character of properties exchanged by the trust and corporation would constitute like-kind property. Because the nonpossessory interest would become a possessory interest and therefore, a fee interest, the rights vested in the parties were substantial.

Related Info: like-kind, interest, corporation, land, owned, parcel


Does filing my tax return end my 1031 Exchange?

You have 180 days to close sale on all of your 1031 Exchange Replacement Properties. However. You need to understand that your April filing date is also the deadline, which mean if the April filing date is before your 180 day deadline, the April filing date trumps your 180 date. The good news is that you can file for an extension. What if you file before the April filing date? Your closing deadline is still the April filing date, UNLESS you file for the extension which the places your 180 day back to the original 180 days after the closing of the property you sold.

Related Info: return, filing, date, april, deadline, extension, closing


When does a 1031 Exchange become taxable?

1031 Exchange is a Yes/No question according to the IRS. Your 1031 Exchange will become a taxable property sale if you fail to follow the rules that were set down by the IRS over 20 years ago. Not following the following rules can force your 1031 Exchange to become a taxable property sale.

Selling a property that is not considered as Like-Kind.
Not using a 1031 Exchange Safe Harbor.
Withdrawing from your proceeds during 1031 Exchange Period.
Failing to Identify your replacements within the 45 day deadline.
Not closing sale on your replacements before the 180 day deadline.

These are just some of rules to follow, more can be discovered in our FREE 1031 Exchange Procedure Manual, which you can access by clicking here!

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How do I beat the 45 day deadline rule in a 1031 Exchange?

The best and ONLY way to "beat" the IRS 45-day Identification Deadline is to Identify your 1031 Exchange Replacement Properties within 45 days of closing sale on the property you are selling. In other words, any attempts to beat this rule other than following it will force your 1031 Exchange to collapse and you will not be able to enjoy the tremendous benefit of deferring your Capital Gains Tax. Any 1031 Exchange Professional who tells you otherwise is either lying, doesn't understand the rule or asking you to commit fraud. As your Qualified Intermediary we can recommend some solid strategies that will help you with this rule. Many tax payers have been known to delay the sale of their property until they know for sure that the property they want to buy is available. Some tax payers even put down an earnest money deposit on their Replacement property before they close on their Relinquished property. This is OK, so long as you take back the deposit at the time of closing and not include it with the proceeds from the sale.

Related Info: rule, deadline, beat, sale, payers, closing, replacement, deposit


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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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


While my 1031 Exchange is being held by a Qualified Intermediary, can I keep the interest?

Yes. This is an arrangement that you will have to make with your Qualified Intermediary. You may interest on proceeds being held in the deferred exchange. You are entitled to receive interest or a growth factor if the amount of money or property you are entitled to receive depends upon the length of time elapsed between transfer of the Relinquished Property and receipt of the Replacement Property.

If you receive interest or a growth factor, the interest or growth factor will be treated as interest, regardless of whether it is paid to you in cash or in property (including property of like-kind). You must report the interest or growth factor in your income according to your method of accounting.

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Can you exchange with your own property?

In order for a 1031 Exchange to be completed, there must be an exchange of properties. You cannot 1031 Exchange with yourself.

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In a 1031 Exchange, do I adjust the sales price to a buyer who gave me 'option money'?

Yes. In a 1031 Exchange, the seller's receipt of compensation for granting an option is treated as a nontaxable event. The rule applies if the option money is applied against the sales price of the property. However, option payments do not lose their nontaxable character merely because they are not offset against the purchase price. The transaction stays open until the option is exercised or forfeited.

At that time it is possible to determine how the option money should be treated tax-wise.

If the buyer exercises the option, the option money is considered part of the sales price of the property and treated as a down payment in the year of sale. If the sale is an installment sale, the option money (no matter when it was paid) is treated as payment in the year of sale and part of the contract price.

If the buyer forfeits, and does not exercise the option, it is treated as a sale of the option by the seller on the date the option expired. The option money becomes ordinary income to the seller. The ordinary income rule applies to all sellers including dealers and investors.

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In a 1031 Exchange, what are the tax effects of receiving boot?

In a 1031 Exchange, all unlike property that is also traded is considered boot. Boot is the same as cash. If you take back boot outside of the 1031 Exchange Period (the time when your Qualified Intermediary is holding your proceeds) the funds are subject to the Capital Gains Tax and treated as income. If you take boot during the 1031 Exchange period, you may pay the Capital Gains tax on the entire 1031 Exchange Proceeds because taking boot during the 1031 Exchange Period will collapse your Exchange and cause it to fail.

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Can you 1031 Exchange with your own property?

In order for there to be a 1031 Exchange it is required that there be an actual sale of property with a different buyer and seller. The 1031 exchange can only happen when there is a real sale between 2 people, or an actual exchange of property. If there is no sale, there is no exchange. Further reading can be found here.

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