1031 Exchange FAQ

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Common 1031 Exchange Questions

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

Is there a penalty if I switch my 1031 Exchange identified properties after the 45 day period?

I bought a rental property 6 years ago with a 1031 Exchange. Will I have tax problems by converting it to my primary residence?

Can I 1031 Exchange real estate AND some stocks for other properties?

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

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

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

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

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

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I bought a house in June 2010 and told the bank that it is for a primary residence. However, I have not lived in the house yet. Does it qualify for a 1031 exchange?

Hi there. Remember that a 1031 Exchange property must be an investment property, such as land or an income producing property such as a rental home.  In order for you home to match the 1031 Criteria, you must show you collected rents from it for 2 tax periods. Some QI's tell customer that it is 2 years but this is not exactly correct. 2 tax periods are 2 tax periods, which means if you bought in June of 2009 by January of 2011, you can show you collected rents for 2 tax periods. The first tax period being part of 2009 and the second tax period being all of 2010. In general, please review our 1031 Exchange Knowledge Base for general information AND consult your CPA or Tax attorney for specifics pertaining to your local area. You can find local CPA's and Tax Attorneys on our web site at http://www.realtyexchangers.com/1031_Exchange/index.html.

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Can I 1031 Exchange my property with no mortgage for one that has one?

You are talking about a 1031 like kind exchange of unencumbered property for encumbered property. Proceed with caution and make sure you know what you are getting into. Here is some important information to consider with your tax advisor.

If you do not assume the mortgage on mortgaged property received in a 1031 exchange, you are taking the property subject to the mortgage. You are treated as if you assumed the mortgage.
If the mortgage you assume is less than the mortgage on the property given up, the net liability—called mortgage relief is counted as boot received by you.
If the mortgage you assume is more than the mortgage on the property given up, the excess is counted as boot paid by you.
If you transfer unencumbered real estate in exchange for mortgaged real estate, you have paid boot equal to the amount of the mortgage. The payment of mortgage boot does not result in recognition of gain or loss to the person paying it.

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When do you figure Fair Market Value on a 1031 Exchange Property?

You would figure the fair market value of Replacement Property at the end of the 45 day 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. However, there are two important exceptions to this rule:

It does not apply to any Replacement Property received by you before the end of the identification period, and
it does not apply to any Replacement Property identified before the end of the identification period and received before the end of the exchange period. However, to qualify for this exception you must receive identified Replacement Property constituting at least95 percentof the aggregate fair market value of all identified Replacement Properties before the end of the exchange period.

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Do I need a broker for a 1031 exchange?

What type of broker are we talking about here? A Real Estate Broker employs the Realtor who will help you to sell your qualified like-kind 1031 Exchange property and buy a replacement. Going it alone is risky, unless you work in the Real Estate industry and have access to the same marketing and research materials that a Realtor has. It's a common fact that people who sell or buy real estate without professional help tend to get less money for their home and pay more for properties than people who do. If you are in the market for a local 1031 Exchange Real Estate Professional, we recommend our directory located here.

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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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I have a 1031 Exchange with multiple properties, how much does this cost?

A 1031 Exchange involving multiple or several properties is possible, though the pricing can be different, depending on which Qualified Intermediary (QI) you use and how many closings you will have. If you sale is structured such that the closing of sale on the properties you are selling happen on different days you QI could charge you for separate exchanges. But if you structure your closing such that all of the properties are listed on one purchase and sale agreement and the title company can work out the closing for one specific day with one set of closing documents, you Qualified Intermediary could just charge you for one closing.  The pricing for 1031 Exchanges range from a few hundred dollars for several thousand depending on the QI and the deal. A complete list of pricing and services for Realty Exchangers is available by clicking here.

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

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

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

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


When does the 1031 exchange 180-day deadline begin?

The 1031 Exchange period begins at the time you sell your property and the proceeds are transferred into Safe Harbor with your 1031 Exchange Qualified Intermediary. From that time one the IRS rule says that you must close sale on ALL identified Replacement properties within 180 calendar days. There are no exceptions, extensions or explanations for missing this deadline. If all of your identified properties have not been purchased, the remaining 1031 Exchange proceeds will not qualified for Capital Gains Tax Deferment.

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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.

Related Info: split, title, partnership, properties, partner, splitting, business


What kind of liability is treated as boot in a 1031 Exchange?

We have a complete write on all the aspects of boot including the liability in our 1031 Exchange Knowledge Base. You can review the article your self at http://www.realtyexchangers.com/1031_Exchange_Information_Center/Topic_3_-_Figuring_Boot_and_Taxable_Gain.php#Topic 3 - Figuring Boot and Taxable Gain, or by clicking here.

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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 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.

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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.

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Does 1031 Exchange apply to selling my primary house?

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

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


What assets qualify for 1031 Exchange?

For 1031 Exchange the real estate you own is considered an asset that must be thoroughly vetted in order to determine if it qualifies for 1031 Exchange. Since we are dealing with IRS matters, you should know that there are 4 classifications of real estate of which only 2 qualify for 1031 Exchange. Your personal residence and the property you purchased for a "quick flip" does not qualify for 1031 Exchange. Your vacant land and your rental home does qualify for 1031 Exchange.

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My place of business is also my residence, can I do a 1031 Exchange?

This is what we call a property with two classifications; each classification is subject to a different set of tax rules. The business portion of the property qualifies for 1031 exchange treatment - the personal residence portion does not. However, the personal residence portion of the property qualifies for the Section 121 250K/500K exclusion on the sale of a personal residence.

The allocation of basis values between the business and the residence portions has already been made on the client's tax return when the business property was set up for depreciation and the allocation for interest and real estate tax deductions.

An exchange sounds like your best bet since the entire property would be exchanged - the business portion would qualify for 1031 treatment - and even though the residence portion is a part of the exchange, since it does not qualify for 1031 treatment, it's treated as a sale and qualifies for the Section 121 exclusion. It's like having your cake and eating it too!

Related Info: residence, business, portion, personal, treatment, qualifies


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.

Related Info: basis, substituted, gain, capital, unrecognized, loss


I just closed on my last 1031 Exchange Replacement Property and have money left over. What can I do with the money?

Your 1031 Exchange ends after you close sale on your last identified Replacement Property. All of the funds that were not spent will be returned to you by your QI. What you do with the money is up to you but you need to realize that these funds are considered Boot and subject to capital gains, even if it's pennies or thousands of dollars. Discuss this with your tax advisor. There are opportunities here if the left-overs are significant.  Your tax advisor will give you ideas such as charity or re-investment.

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

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

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

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

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

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Do the 1031 Exchange rules apply to off-shore companies?

1031 Exchange rules apply to all US taxpayers. If the offshore company you are asking about  is a US Taxpayer and both the of the 1031 Exchange properties are located within in the fifty states or the US Virgin Islands, and the properties are either investment real estate or business real estate, then the answer is Yes

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In a 1031 Exchange, what is the classification "real estate held for sale"?

Of the IRS's 4 classifications of  Real Estate this term can be the most difficult to taxpayers to grasp. The correct term is "real estate held for sale to customers". Our 1031 Exchange Knowledge Base has a very insightful article about this subject. Here is an excerpt that will be very valuable to you.
"This classification is known as dealer property. To be classified dealer property, the property must be held at the time of sale or exchange
primarily for sale
to customers
in the ordinary course of business.
All three elements must exist at the time of sale or exchange or the property will not be classified dealer property. Primarily for sale means of the first importance. It does not have to constitute more than 50% of the purpose—it need only be the most important. The Supreme Court said, “If an owner acquires a property for rental or investment use, but also plans to sell the property and realize gain in any way he can if the original plan becomes unfeasible, he does not hold the property primarily for sale.”
All buyers of real estate are customers as the term is used here. The activity “in the ordinary course of business” must be directly related to the sale of that property. In addition, the activity must be “busy.” The two “busy” activities usually related to sales or exchanges are
1. sales activities related to the property, and,
2.physical improvements to the property.
Many people, including many IRS agents, misunderstand this activity. To be classified dealer property, there must exist a busy business activity directly related to that property. If you buy a parcel of land, subdivide it, and build houses for sale, there's no question you have dealer property. But if you buy a parcel of land, make no physical improvements, subdivide it by getting it rezoned and meeting other legal requirements, and sell it in the form of an unsolicited offer—you get capital gain treatment. The reason? No business activity related to the property. [iii]
If the property is listed with a licensed real estate broker, the sales activities of the real estate broker are not considered to be the sales activities of the owner.
The Tax Court has held the real estate activities of corporations owned or controlled by an individual cannot be attributed to him even though he may be engaged full-time as an officer of the corporation.
Licensed real estate brokers and salespersons ordinarily are not dealers. In Scheuber v. Com. 371 F2nd 996, it was held properties purchased by a licensed real estate broker (who intended ultimately to sell) and held for realization of appreciation in value over a substantial period of time were capital assets.
If dealer property is sold at a gain, the gain is taxed as ordinary income. If dealer property is sold at a loss, the loss is deductible as an ordinary loss."

Related Info: sale, estate, real, classification, dealer, related, activity


How do I do a 1031 Exchange in Texas?

1031 Exchange is a federal action involving the IRS and US Tax Payers. As Texas is one of the 50 states, completing a 1031 Exchange in that state should be no problem so long as the property you sell and the property you purchase are both considered of like-kind investment or business real estate. You do not have to use a Qualified Intermediary that resides in Texas, you may use any Qualified Intermediary that you wish, though we highly recommend Realty Exchangers, Inc, a 21 year company with an impeccable reputation for quick, easy and secure 1031 Exchanges.

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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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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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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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Can I sell my condo as a 1031 Exchange even though I intended to rent it?

If you sell your condo right now, would the amount realized from the sale (sales price minus all selling expenses including commissions, etc.) be more than their cost of the condo including closing costs? If you have no gain, a 1031 Exchange wouldn't make any sense. If there is a gain, the property should qualify for §1031 treatment since the need and decision to sell are considered an unrelated event to the purchase.

Pay attention a 1031 exchange of depreciable property that has appreciated in value. If the basis of the old property is “substituted” into the new property, your depreciation deductions may be affected. On the other hand, a sale and purchase could result in a higher cost basis in the new property and higher depreciation deductions.

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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


How do I figure the basis in my 1031 Exchange Replacement Property?

The rules for figuring basis for property acquired in a 1031 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.

More reading and information can be found here!

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