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1031 Exchanges Explained

Property investors have a powerful tool for building and preserving their real estate wealth: The 1031 Tax-Deferred Exchange. Section 1031 of the Internal Revenue Code allows investors to defer (postpone) paying income taxes on gains from the sale of investment real property, if the proceeds are re-invested into "Like-Kind" property. You must have held the Relinquished Property (the "old" property) and you must hold the Replacement Property (the "new" property) for investment or for productive use in a trade or business.

1031 Exchanges Explained - Additional Information

Like-Kind Property

Like-Kind refers to the type of property being exchanged. You can exchange any real estate investment for any other type of real estate investment -- for example, vacant land can be exchanged for rental property. In most cases, your personal residence is not Like-Kind investment property.

Personal Property Exchanges

For 1031 exchanges of investment personal property or equipment (i.e. aircraft, boats, and equipment) the type of personal property must be matched almost exactly. Please call for details.

Exchanging Up

To accomplish a fully tax-deferred exchange the rule of thumb is: Exchange even or up in value and Exchange even or up in equity.

Boot

To the extent that you do not exchange even or up in value and exchange even or up in equity, you will have received non-qualifying property ("boot") in your exchange. If you receive boot, tax is computed on the amount of gain on the sale or the amount of boot received -- whichever is lower. Common forms of boot include:
  

  • Cash to exchange or

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  • Debt relief to exchange or

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  • Notes or contracts to exchange


  • Simultaneous Exchanges

    In a Simultaneous Exchange, your old property is exchanged for new property at the same time in an interdependent closing. Often, there are practical reasons which prevent a Simultaneous Exchange. Your new property may not yet be located or ready to close before the required closing date for the old property. In such cases, a successful exchange can still be completed on a deferred (delayed) basis.

    Delayed Exchanges

    In a Delayed Exchange, your old property is exchanged for a promise from someone (usually a facilitator company) to acquire new property for you at a later date. In 1984, Congress authorized Delayed Exchanges in Section 1031 of the tax code. In 1991, the IRS issued Final Regulations on how to successfully complete a Delayed Tax-Deferred Exchange.

    Time Deadlines

    In a Delayed Exchange, you are required to "identify and designate" your new property on or before 45 days from the transfer of your old property...

    ...and Closing must occur on one or more of the properties you have identified and designated within 180 days of the closing of your old property, or before the due date for filing of your tax return for the year in which the old property closed, whichever is earlier.

    You can always get the full 180 days to complete your Delayed Exchange if you timely request an extension for filing your tax return.

    Identification

    The IRS Regulations limit your flexibility in identifying and designating new properties. You must provide a written description (street address and/or legal description) of your proposed new property (ies) to the facilitator no later than midnight of the 45th day. You can identify and designate up to three properties regardless of value. You don't have to buy all three. If you identify more than three properties, you are limited by a value test for the identified properties. The total value of all the properties you identify cannot exceed 200% of the old property value.

    Exchange Facilitator guides you through the identification and designation process with forms and instructions detailing how these rules affect your particular exchange.

    Reverse Exchanges

    1. A reverse exchange may be required where the new property purchase must be closed before the old property sales closes.

    2. This type of exchange was recently authorized by an IRS Revenue Procedure effective September 15, 2000. This Revenue Procedure gives specific guidelines and time deadlines.

    3. A reverse exchange involves a great deal of advance planning with your facilitator.