1031 Exchange FAQ

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Common 1031 Exchange Questions

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

Can I 1031 Exchange a rental home with my sister?

How do I figure my 1031 Exchange Closing Costs?

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

If I sell my 1031 Exchange relinquished property in 2010 and purchase my replacement property in 2011, what year do I send the IRS 8824 form?

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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What are the 1031 Exchange laws regarding turning a 1031 exchange property into a personal residence?

What you are asking can be tricky. The 1031 Exchange Replacement Property must be acquired and held as a rental or a property held for investment. You need to show that this is your intent. The code and regulations are silent regarding a specific holding period before your property can be reclassified as a personal residence. But we've seen that rulings and opinions point to a minimum of two tax periods before you can convert it to a personal residence.

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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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Can a building with more than one shared interest qualify for 1031 exchange if part of the shared interest is already sold?

We are prevented from providing direct tax or legal advice. The answer to your question is probably yes, the un-sold portion of the partnership may qualify for 1031 Exchange.  Make sure the property is deeded as un-divided interest for the remaining shareholders. Just make sure to discuss this in detail with your Tax Advisor or Attorney.

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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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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

What is a 1031 Exchange, tax-deferred Exchange, like-kind Exchange, Real Estate Exchange, Starker Exchange?

These terms ALL describe a Federal Internal Revenue Service Section 1031 Exchange. Though the names are different, they each mean the same thing though each has a different origin, some dreamt up by a marketer others by different industries. Real Estate pros like to call them Real-Estate Exchanges. Tax Pros like to call them tax-deferred Exchanges and investment pros like to call them like-kind Exchanges. Starker Exchanges have their own history was the name for them before the IRS called them 1031 Exchanges.

So what is a 1031 Exchange?

To understand 1031 Exchange, you must look to its legislative design. Congress intended non-recognizable taxable gain or loss if the Replacement Property received is merely a continuation of your old property investment. To qualify, you must structure and complete your exchange transaction in accordance with the requirements of §1031. Your intent doesn't count — what you actually do is what determines if you qualify or not. However, if the transaction is ambiguous, the Courts may look to intent of the parties. See Step Transactions and Substance over Form Doctrines—for more discussion on this matter.

Section 1031 provides for nonrecognition of gain or loss if three conditions are met:

Only property held for investment or use in your trade or business qualifies for §1031 exchanges. Both the property exchanged by you and the property received by you must be qualified. Personal use property such as your personal residence does not qualify. Nor does “dealer” property.
The properties must be of like-kind. They do not have to be identical. This is a very broad definition. All qualified real estate is of like-kind with all other qualified real estate.
There must be an actual exchange of properties. There can be a transfer of money with the qualified property. This will not disqualify the exchange. Taxpayers lose most tax cases involving exchanges because their transaction fails to meet the requirements of §1031 for a reciprocal transfer of property.

Related Info: starker, estate, real, like-kind, tax-deferred, exchanges, qualify, different, transaction, investment

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.

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Why does my 1031 Exchange show a gain even if I didn't have any boot?

In a 1031 exchange, you can still have a even if you have no boot at all! Very few know this rule but it is possible to 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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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.

Related Info: land, investment, sale, difference, estate, real, types, purchase

I heard there were different 1031 Exchange rules for people who are related. How do you define related?

A related person can be defined as:

Your family but only brothers and sisters (including half-blood), spouse, ancestors, and lineal descendants.
You and a corporation if you own—directly or indirectly—more than 50% in value of the stock. Or if the stock is owned for you.
Two corporations that are members of the same controlled group.
A grantor and a fiduciary of any trust.
A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts.
A fiduciary of a trust and a beneficiary of the same trust, if the same person is a grantor of both trusts.
A fiduciary of a trust and a corporation if more than 50% of the value of the outstanding stock is owned—directly
A corporation and a partnership if you own (1) more than 50% of the value of the outstanding stock of the corporation and (2) more than 50% of the capital interest or the profits interest in the partnership.
An S corporation and another S corporation if you own more than 50% in value of the outstanding stock of each corporation.
An S corporation and a C corporation if you own more than 50% in value of the outstanding stock of each corporation.

By the way, here the is 2 year related party rule, explained:
If property received in a 1031 exchange between related persons is disposed of before two years after the date of the last transfer in the exchange, the related taxpayer 2-year time rule applies. Any gain or loss not recognized on the original exchange will trigger and be recognized as of the date the property is disposed of.indirectly—by or for the trust or by or for a person who is a grantor of the trust.

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What is a Reverse 1031 Exchange and how do I do one?

You should also ask why you want want to do a Reverse Exchange? There are some circumstances during a 1031 Exchange where you may want to purchase a replacement property before you sell your relinquished property. Especially if the property you want to buy is a bargain or there is much competition for it. This is known as a Reverse Exchange.

If the Relinquished Property is sold before the Replacement Property is acquired, you follow the safe harbor rules of Reg 1.1031(k)-1 and transact a normal or forward exchange. However, if you are unable to dispose of your Relinquished Property first, it is still possible to qualify for the desired tax treatment of §1031 by following the safe harbor rules of Rev. Proc. 2000-37. However, the safe harbor rules of Rev. Proc. 2000-37 require many complicated legal steps including the creation of an Exchange Accommodation Titleholder entity and other agreements. Since these required procedures can result in several thousand dollars of legal and substantial additional risk, we recommend you consider using the reverse exchange safe harbor procedure only if the size of your transaction and resulting savings in capital gains tax justifies the additional fees and expense.

Reverse Exchanges can become very expensive and much planning should be considered before you execute one. Discuss this thoroughly with your tax advisor.

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What happens when I 1031 Exchange a mortgaged property for another mortgaged property?

1031 Exchange transactions are a bit more complicated when both of the properties are mortgaged. If you are going to exchange a mortgaged property for another mortgaged property, you need to know that each party assumes the liability of the other's property. The liabilities of one are offset against the liabilities of the other. Only the excess is treated as net boot given or received. The mortgages become netted. How this works is you would deduct the mortgage of the property you assume from the mortgage on the property you are giving up. A good idea would be to meet with your tax advisor, CPA or attorney and discuss this at length.

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My 1031 Exchange is with my son and his wife for less than it's worth. Will I have tax problems if I report a loss?

Yes, you may have some tax problems here on the 1031 Exchange of this property.

Under the bargain sale concept, property sold at less than fair market value is treated as a gift of the difference between the sales price and actual value. Here is an example of how it works: Mother sold land to Son for what she believed to be the fair market value of $100,000. The land was actually worth $215,000. The Tax Court ruled she had to pay a gift tax on $115,000 - the difference between the sales price of $100,000 and fair market value at time of sale of $215,000. And, adding insult to injury, she had to pay a penalty for failing to file the gift tax return plus a negligence penalty.

This does not mean you cannot make the bargain price sale. Your small loss will probabley not be deductible, It’s OK to sell for less as long as the difference is treated as a gift and required gift tax returns are filed. Be sure to have the fair market value at the time of sale determined by a qualified real estate appraisal. If audited by IRS, the appraisal will validate the your position.

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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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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.

Related Info: properties, replacement, purchase, rule, purchasing, options

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.

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In a 1031 Exchange, do I have to close sale on ALL of my identified replacement properties?

Believe it or not, the answer to this question is entirely up to you. If your goal is to defer your capital gains tax, then yes you are expected to close on all of your identified 1031 Exchange replacement properties. However, sometimes these deals fall through. There is no law that says you "MUST" close on all of your properties, but remember that any remaining proceeds left over from the sale of your relinquished property are subject to the capital gains tax.

Related Info: properties, replacement, identified, sale, gains, capital, says, relinquished, remaining

What is the procedure for changing my identified property after 45 day period for 1031 exchange?

Unfortunately, the IRS did not allow for this, which means once you have identified your 1031 Exchange properties and the 45 days period has expired, you cannot identify anymore or change them, they are locked in. Careful consideration must be taken as you identify to insure that you have identified properties that you know you are going to purchase. If the 45 day period expires and you haven't identified any properties, your 1031 Exchange is over and you will owe the capital gains tax on your sale. Your Qualified Intermediary will help you remember your identification dates and your Realtor can help you secure new properties.

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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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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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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.

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What is the 1031 Exchange Period?

The 1031 Exchange period is considered the time AFTER you close sale on your property until you purchase your last Identified Replacement Property. This period of time can be no longer than 180 days and you are not able to access any of your 1031 Exchange proceeds during this time for any other reason than purchasing your replacement properties. Using your Exchange proceeds for anything other purchasing replacement properties puts your exchange in danger of collapsing. This is something you should avoid.

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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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I'm trying to 1031 Exchange a property that I converted into a vacation rental. Is listing it with a rental agency enough?

Yes - listing the property for rent with a licensed real estate broker at fair market value is treated by the IRS as a serious effort to rent the property. It must be a bona-fide listing and vacant during the time - in other words, you cannot occupy the property or use it as a vacation home. If you do, that time will not count as operating a rental property.

If you don’t list the property with a broker but hold it as a “rent-by-owner”, the property cannot qualify as a rental property until it is actually rented, no matter how much effort you make to rent it. It will be classified as property held for personal use and will not qualify for 1031 exchange treatment.

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Is fixing up a property to sell for 1031 Exchange considered a selling expense?

In a 1031 Exchange, selling expenses include what it cost you to sell your property, this includes the marketing by your Realtor and the fees charged by the closer or Qualified Intermediary to sell your property. Fixing a leaky roof or adding new siding is not considered a selling expense. Adding a new room or garage is considered a Capital improvement but fixing a leaky roof is considered maintenance and is not deductible from your 1031 Exchange.

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In a 1031 Exchange, are there any other closing costs other than the fee to the Qualified Intermediary?

When you sell your 1031 Exchange property it is no different that any other sale. When you sell any property, there are laws and rules to be followed in your city, county and state which must be followed. These include Title insurance, Warranty deeds, Closing company fees, Realtor's fees and all of the other fees associated with lawfully selling real estate. The Fees you would pay your Qualified Intermediary are a small  part of these fees. Typically, they are listed in the HUD Settlement statement and are paid by the closing company.

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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

Can a realtor earn a commission for a 1031 exchange?

Another common question for taxpayers new to 1031 Exchange. Realtors are very useful when it comes to marketing real estate and many will certainly earn their keep and when it comes to working with 1031 Exchange property, their use is no different. 1031 Exchange is no different than a straight property sale, while you the taxpayer may have a few more hoops to jump through, your Realtor will do the same work and should be paid accordingly. Just don't forget that you don't pay tax on the cost of market your property or the cost to finance or close sale on your property. Can a Realtor earn a commission on a 1031 Exchange property? We expect it and embrace it.

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What are the 1031 Exchange Penalties?

In the case of a 1031 Exchange action taken by the taxpayer, there are no "penalties" per se, as whether a 1031 Exchange happened or not comes down to a yes or no question.

Was the property sold a qualifying like-kind property?
Did the taxpayer follow the safe harbor rules utilizing a Qualified Intermediary?
Was the replacement property identified within 45 days of the close of sale on the relinquished property?
Did the replacement property qualify for like-kind Exchange?
Was the purchase of the replacement completed within 180 days of the close of sale on the relinquished property?

If you can demonstrate a yes answer to the IRS for the above 5 questions, chances are quite high that you had a 1031 Exchange and can reap benefit of deferring your capital gains tax.

If one of these questions produces a no answer, the only penalty available is the IRS would consider your Exchange a straight sale and you would be subject to the capital gains tax for the same year that you sold your property.

Related Info: penalties, sale, replacement, questions, capital, gains, like-kind

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