1031 Exchange FAQ - PRIMARY

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Common 1031 Exchange Questions

Can i enter a 1031 exchange on my primary residence if i run a trade or business from it?

How do I figure out my taxable gain in a 1031 Exchange?

In a 1031 Exchange, what happens if both parties have mortgages?

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 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?

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.

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Can i enter a 1031 exchange on my primary residence if i run a trade or business from it?

Great question. Your primary residence is excluded from 1031 Exchange as it is not considered like-kind by the IRS. The fact that you are running your business from it does not matter. Consider the farmer who runs his farm from his home. While the land his farm occupies may qualify for 1031 Exchange, his home, even though he ran the business from his home, does not qualify for 1031 Exchange and must be treated as a straight sale. These are called Mixed Classification exchanges and more information about them can be obtained in our 1031 Exchange Knowledge Base.

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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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I bought a house in june 2010 and told the bank that it is for primary resident. However, I have not lived in the house yet. Do 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 CPA's and Tax Attorney

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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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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.

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Can I 1031 Exchange a rental property and purchase a primary residence with the proceeds?

No. 1031 Exchange rules require that the relinquished property and the replacement property be of like-kind. What this means is that they both must be either a business property such as a rental or an investment property, such as land. The sale you mention will incur the capital gains tax. If your goal is to defer those taxes, your 1031 Exchange replacement property must be of like-kind qualify for IRS 1031 Exchange.

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

Excellent question. So long as you can prove that the property has been collecting rents for the past 2 tax periods, you should have no trouble converting your 1031 Exchange rental property into your personal residence. Just be aware that when you do this if you ever decide to sell the property as a 1031 Exchange, you'll need to convert the property into a rental again and be able to prove that you collected rents from it for 2 tax periods.

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What property does not qualify for 1031 Exchange?

Often, when discussing 1031 Exchange Qualified Properties, it is better to discuss properties that DO NOT qualify for 1031 Exchange treatment.
This is important because if you transfer property that does not qualify for 1031 Exchange it will be treated as a regular sale of the property and subject to capital gains.

The following types of property are excluded from nontaxable 1031 Exchange treatment or you cannot 1031 Exchange the following:


Property held for personal use such as your primary residence.
Dealer property or stock in trade and property held primarily for sale such as inventories and real estate held by dealers.
Stocks, bonds, notes, or other securities or evidences of indebtedness such as accounts receivable.
Partnership interests.
Notes
Choses in action.
Certificates of trust or beneficial interest


Related Info: qualify, sale, notes, treatment, following, properties


I'd just converted my house into a rental home. How long before I can 1031 Exchange it?

In order for your primary residence to be considered for 1031 Exchange treatment it must considered as "Real Estate Held for Business" use and not "Real Estate held for personal use". We recommend that you should be collecting rents on the property for at least 2 tax periods so that you can prove to the IRS that property is now a business. This can be tricky and several other professionals will offer up different numbers or theories as to how long you should be collecting rents on a property before it can be considered for 1031 Exchange. It is our experience in over 20 years in this industry that 2 tax periods is ample time to prove a property is a business. Better safe than sorry. Remember, the IRS controls every aspect of the 1031 Exchange. Best not to give them reasons to disqualify your 1031 exchange.

Related Info: home, rental, house, converted, business, rents, periods, prove, estate, collecting


How do I do a 1031 Exchange?

We've been reading countless daily internet articles explaining the benefits and the whys of an IRS 1031 Exchange. The reasons why someone should do a 1031 Exchange are quite simple, the taxpayer wants to defer their capital gains tax. But what about how? How do you do a 1031 Exchange?

1. Own Qualified Real Estate.

Make sure you have real estate that qualifies for 1031 Exchange. Make sure you or your business owns either investment real estate, such as land. Or, real estate held for business use, such as a rental property or an office complex. Careful consideration of your property must be taken into account. Do not be fooled by individuals telling you you can 1031 Exchange your primary residence or property you purchased yesterday with the intent to flip tomorrow. This is a horrible trap. Consult your CPA for more information.

2. Find a buyer

Realty Exchangers has two very popular venues for finding buyers of your property and finding 1031 Exchange pros who know how to make all happen. Visit our 1031 Exchange Property Search Engine to find looking at http://www.exchangersclearinghouse.com. You can also look up a local professional with our 1031 Exchange Pro Directory located at http://www.realtyexchangers.com/1031_Exchange/index.html. Both of these services are free!

3. Accept the and write up a purchase and sale agreement.

Work with your buyer and attorney to make sure all parties are happy with the offer and that all contingencies are considered. Be sure to inform the buyer that this is a 1031 Exchange.

4. Contact a closing company.

Finding the right closing/title company can be a chore. Your attorney or real estate agent may have some ideas of which closing company to use, better to find one that knows how to handle 1031 Exchanges.

5. Setup a 1031 Exchange with a Qualified Intermediary. (QI)

Choosing your 1031 Exchange QI is important. You need one with experience and integrity. Realty Exchangers has been providing 1031 Exchange QI services since 1989. In over 20 years, we helped thousands of tax payers defer their capital gains tax. We are the experts at making the transaction simple and easy.

6. Close sale on your property and transfer your proceeds into your QI's trust.

When you sale closes, you closing company is directed to transfer the proceeds from your 1031 exchange into your QI's trust account. Here the funds will sit while you search for your 1031 Exchange Replacement Property.

7. Know your 45 day and 180 day deadlines.

Soon as the sale closes on your Relinquished Property the clock starts ticking on securing qualified Replacement Properties.

45 day Identification Period. The IRS stipulates that you have 45 days to officially "Identify" your replacement properties. This must be done in writing and Realty Exchangers provides you with the forms necessary.
180 Closing Deadline. The IRS also stipulates that you have 180 to close sale on ALL of your identified replacement properties.

8. Identify your Replacement Properties.

Use the same web site tools mentioned in number 2 above. These must be of like-kind, meaning they must follow the same qualifications test as mention in step 1. The number of Replacement Properties you can chose, depends on which rules you want to follow. The 3 property rule, the 200% rule or the 95% rule. The most popular is the 3 property rule because it is the easiest for most people to understand.

9. Close on your Replacement Properties.

Essentially, this step is the same as steps 3 and 4, mentioned above.

That is all there is to it.

Realty Exchangers takes pride in keeping this process as clean and simple as possible. Only when you attempt to circumvent the above steps do you invite trouble with your 1031 Exchange. You have two options with the IRS. Pass or Fail. If you follow the rules, your Exchange will pass and you will defer your capital gains. Failure to follow the rules or attempts to circumvent the process creates issues that can force your Exchange to collapse.

And always, if  you have questions, the best option is to call Realty Exchangers at 800-570-1031.

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Can I 1031 Exchange Property I purchased from a 1031 Exchange 4 years ago?

Good question. To 1031 Exchange any property, you need to consider a few things. First, what kind of real estate is the property we are talking about? If it's land, the answer is almost always going to be yes because land is always considered real estate held for investment purposes.  If the property is an apartment building which you have been actively collecting rents from, the yes, the property qualifies for 1031 Exchange. However, if this property is a rental home that you converted into your primary residence then the answer is no because you changed the classification of the property and property that is your primary residence does not qualify for 1031 Exchange.

Related Info: years, purchased, residence, land, estate, real, primary, home


How long can I own a 1031 Exchange Rental property before I can live there?

Remember, it's all about intent. For example, if, at the time of your 1031 exchange, you had no intention of converting your rental into your primary residence but an unforeseen event, not related to the exchange, takes place—perhaps the death of a spouse. Or the rental turns out to be an unbearable negative cash flow situation. You should be able to demonstrate to the IRS your original intent. In such cases, you should have no problem supporting your 1031 exchange.

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If I 1031 exchange into a rental, how long before I can live there?

It’s a matter of facts and circumstances. For example, at the time of the 1031 exchange, you have no intention of converting it to your primary residence. But an unforeseen event, not related to the exchange, takes place. Perhaps the death of a spouse. Or the rental turns out to be an unbearable negative cash flow situation. In such cases, you should have no problem supporting the like-kind exchange.

We recommend that you hold the Replacement Property for at least two years.

If you have any doubts or questions about the classification of either your Relinquished Property or Replacement Property, be sure to discuss it with both your tax professional and your real estate agent.

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How long do I have to wait before I can 1031 Exchange my property?

We know both the Relinquished Property and the Replacement Property must be held for use in a trade or business or for investment qualify for 1031 Exchange. But we don't know exactly how long. The statute is silent on this issue.  There is no safe holding period for property to automatically qualify.

IRS has ruled that property transferred to a controlled corporation immediately following the exchange did not qualify. [ix] However, a general intention to make a future transfer is probably OK. In one case, the taxpayer gifted the Replacement Property to his children nine months after the exchange. The court said the exchange was OK because even though the taxpayer contemplated eventually gifting the property to his children, he had no concrete plans to do so at the time of the exchange. [x]

To be on the safe side, you should hold the Replacement Property for at least two years.

The two-year holding period pops up in many places. That’s the minimum holding period applying to the exchange with a relative rule. It’s the same for the installment sale rules between related parties. And it’s also the minimum time period a taxpayer must live in their primary residence to qualify for the §121 exclusion benefits on the sale of the residence.

If you have any doubts or questions about the classification of either your Relinquished Property or Replacement Property, be sure to discuss it with both your tax professional and your real estate agent.

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How secure are my 1031 Exchange funds?

The security of your funds is not something you should have to worry about while completing your 1031 Exchange. For over 20 years now the safety of client proceeds is of highest importance to us.  Here's what we're doing about it.

There are two primary areas of concern:

1. The Bank where client funds are deposited (Riverview Community Bank).
2. The Qualified Intermediary (Realty Exchangers, Inc.).

1.) The Bank: Although our bank is considered strong and very well capitalized the only real safety for bank accounts today is "FDIC" (Federal Deposit Insurance Corporation) insurance. Riverview has qualified for the FDIC's Transaction Account Guarantee Program and ALL OF REALTY EXCHANGERS ACCOUNTS ARE NOW "FDIC" INSURED. Unlike previous "FDIC" insurance there is no upper limit on the amount.

2.) The Qualified Intermediary: As we have seen, with all the recent bankruptcies and business failures, neither size, a prestigious name, belonging to a trade group, or hiding behind a title company or other large entity, will assure the safety of your funds. We are Licensed, Insured, and Bonded but none of that will really protect you either. The only real protection is a QUALIFIED ESCROW AGREEMENT. This is a separate signed agreement between you, us, and the bank, which requires you to approve in writing any withdrawal of your 1031 funds. At the same time it keeps control of the 1031 funds with Realty Exchangers, Inc. thereby meeting the IRS's §1031 requirements (see note below). Unless otherwise requested ALL EXCHANGE ACCOUNTS WILL NOW INCLUDE A QUALIFIED ESCROW AGREEMENT.

Note: The Qualified Escrow Agreement is signed by all parties at the time of closing of the relinquished property. When the 1031 funds are wired into Realty Exchangers account the bank places a hold on the account. Then when the exchanger is ready to close on the replacement property a form is signed by the exchanger (you) that authorizes the bank to release the specified amount to that escrow as requested by Realty Exchangers wiring instructions. Quite simply, the exchanger will have to authorize any use of their 1031 funds.

We want you to feel secure and able to devote your full attention to the structure and completion of your 1031 exchange knowing that your funds will be there when you need them.

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Someone told me I can 1031 Exchange my Condo, that true?

The biggest issue you have to look at if you plan to 1031 Exchange your condominium is if you are currently living there as a primary residence.

If you use your condominium as your primary residence, and sell it, the rules applying to the sale of your primary residence will apply.

But, if you use your condominium as rental income property, all the rental deduction and income rules apply and it may qualify for 1031 exchange.

The cooperative form of ownership is similar to condominium ownership. Both involve the collective control of certain facilities of the project and common areas. The difference between the two is the way title is held. The condo owner has fee simple title in a specific unit. The development’s facilities and common areas are jointly owned with other condo owners. Under cooperative ownership, a corporation owns the entire residential building. Each “tenant” owns stock in the corporation and leases a particular apartment from the corporation with rights to occupy the apartment as his or her primary residence. The stock owned by the “tenant” is treated by the IRS as the equivalent to ownership of a primary residence.

Selling stock in a cooperative is treated as the sale of your primary residence. However, if you use your cooperative as rental income property, all the rental deduction and income rules apply and it may qualify for 1031 treatment.

Consider this, as we get this question a lot! Just because you rent out your residence does not necessarily mean the property loses its classification as your primary residence. There are rules for this and you must look at the facts and circumstances of each case to determine this. This presents a real danger if the primary purpose of converting your residence to a rental is to qualify for a subsequent 1031 exchange. Consult your CPA if you are considering selling your condo as a 1031 Exchange.

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I have a note secured with real estate, can I 1031 Exchange this for another property?

Real Estate notes  are always excluded from 1031 Exchange treatment and will not qualify.

Sometimes you have property you want to sell yet some of the items do not qualify for 1031 treatment.

A transfer of that property in an exchange transaction will be treated as a sale of that property.

Section 1031 excludes these assets from nontaxable treatment:

Property you hold for personal use such as your primary residence.
Stock in trade and property held primarily for sale such as inventories and real estate held by dealers.
Stocks, bonds, notes, or other securities or evidences of indebtedness such as accounts receivable.
Partnership interests.
Notes
Choses in action.
Certificates of trust or beneficial interest


Related Info: estate, real, secured, notes, treatment, qualify, sale


How do I use the personal residence exclusion in my 1031 Exchange taxes?

If you make more than one sale during the 2-year period and claimed the exclusion on your tax return, and sell another primary residence within the 2-year period, you cannot exclude the gain from the second sale. You must include the gain in your income. However, there are exceptions to this rule.

If you sold the residence and did not meet the ownership and use tests, you may exclude a reduced amount if you sold the residence due to:

A change in your place of employment.
Health.
Unforeseen circumstances to be determined by the IRS.

The amount of exclusion is the ratio of the number of months you owned and lived in the primary residence multiplied by 24 months. For example, if you owned and lived in the property for 12 months, your ratio would be 12 months/24-months or 50 percent.

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How do I u?

If you make more than one sale during the 2-year period and claimed the exclusion on your tax return, and sell another primary residence within the 2-year period, you cannot exclude the gain from the second sale. You must include the gain in your income. However, there are exceptions to this rule.

If you sold the residence and did not meet the ownership and use tests, you may exclude a reduced amount if you sold the residence due to:

A change in your place of employment.

Health.

Unforeseen circumstances to be determined by the IRS.

The amount of exclusion is the ratio of the number of months you owned and lived in the primary residence multiplied by 24 months. For example, if you owned and lived in the property for 12 months, your ratio would be 12 months/24-months or 50 percent.

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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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In a 1031 Exchange, exactly what property does NOT qualify?

In some cases, you may find that all or some of the property you want to sell fails to qualify for 1031 Exchange. Be sure to check out our 1031 Exchange Knowledge Base for more information about dealing with un-like property. Check out Topic 3 by clicking here.

Examples of un-like property which are excluded from nontaxable treatment are:

Property you hold for personal use such as your primary residence.
Stock in trade and property held primarily for sale such as inventories and real estate held by dealers.
Stocks, bonds, notes, or other securities or evidences of indebtedness such as accounts receivable.
Partnership interests.
Notes
Choses in action.
Certificates of trust or beneficial interest

It doesn’t matter if any of the excluded property items are related to real estate; they are always excluded from §1031 treatment. For example, a note secured by real property can never qualify.

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Is it possible to 1031 Exchange my personal residence for a business-related property?

The IRS had written some very clear and concise rules regarding whether your personal residence would ever qualify for 1031 Exchange. We have seen several articles recently where some tax guru has worked up a strategy for making this happen. And there may be some circumstances where this might have worked. But the facts are and remain, your personal residence DOES NOT qualify for IRS 1031 Exchange. There are ways to convert your home into a rental but that will take at least 2 tax periods before your property could qualify. Check out our 1031 Exchange Knowledge base article regarding this situation at http://www.realtyexchangers.com/1031_Exchange_Information_Center/Topic_8_-_Exchanges_Involving_Primary_Residence.php#Renting_out_your_old_residence.

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I want to 1031 Exchange a 4-plex but I live in one of the units. How does that work?

What we are talking about here that you want to 1031 Exchange a property that has a mixed classification. The 4-plex qualifies for IRS 1031 Exchange because it is considered a property held for business. The single unit that you live in is classified as your primary residence, which does not qualify for 1031 Exchange.

1031 Exchange sounds like a great idea in these situations because 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! Great question!

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