1031 Exchange Requirements
The 1031 Tax Deferred Exchange has been a foundational part of our tax code for almost 100 years dating back to the 1920s. Real estate investors have strong incentives to buy, sell, and exchange real property which is good for our economy and in turn all Americans.
However, there are strict codes and guidelines that must be followed and you cannot do this on your own. To qualify for a 1031 exchange the seller of the property must use the services of a Qualified Intermediary who acts as a trust and compliance agent for the exchange.
Some of the strict guidelines that every investor must be aware of are as follows:
Like Kind Property for Replacement Per IRC Guideline
45 Days, 180 Days, and Identification Rules: What You Need To Know
The rules for new property identification in a 1031 exchange are strict and must be followed to the letter of the rule. Investors MUST identify in writing a new replacement property for the real estate being sold within 45 days of the sale of the original property, and the new investment property must be purchased and closed within 180 days from the sale of the original property. You will want to have the support of your Qualified Intermediary in properly documenting and meeting your new property identification requirements.
Boot
In instances where some of the above-mentioned requirements are not met all may not be lost, BUT the amount by which the equity or debt or property value falls short of the requirement is considered the “boot” and subject to taxation.
This concept is true of all forms of the taxable boot regardless of whether the boot is value, cash, or mortgage boot.
Expenses and certain fees can have an effect on the value of the exchange transaction and in turn the amount of the boot. Some of the expenses that can be paid with exchange funds are CPA fees, legal fees, QI fees, real estate person’s commissions, and certain title fees.
What cannot be paid with exchange funds include costs which are not fees at all but might be due at settlement. These might include insurance, taxes, repairs or maintenance, and certain financing fees.
Resources: FAQ
What are the time limits to complete a Section 1031 Deferred Like-Kind Exchange?
While a like-kind exchange does not have to be a simultaneous swap of properties, you must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters.
The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. However, notice to your attorney, real estate agent, and accountant or similar persons acting as your agent is not sufficient.
Replacement properties must be clearly described in the written identification. In the case of real estate, this means a legal description, street address or distinguishable name. Follow the IRS guidelines for the maximum number and value of properties that can be identified.
The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.
Can the 45- and 180-calendar day tax-deferred exchange deadlines be extended?
No. These deadlines are actually part of the Internal Revenue Code and cannot be extended for any reason except by a Presidential Disaster Declaration. The deadline is not extended if it falls on a Saturday, Sunday or legal holiday.
Should identifications be made to the intermediary or an attorney, escrow, closer or title company?
Identifications may be made to any party listed above. However, many times the escrow holder or closer is not equipped to receive your identification if they have not yet opened a transaction file. Therefore, it is easier and safer to identify through the Qualified intermediary or facilitator provided the identification is postmarked or received within the forty-five-day identification period.
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 sent before the end of the identification period to a person (other than yourself or a related party) involved in the exchange.
Is there a simple rule for structuring an exchange where all the taxable gain can be deferred?
Yes, if you:
- Purchase a replacement property which is equal to or greater in value than the net selling price of your relinquished (exchange) property, and
- Move all equity from one property to the other; the gain will be totally deferred.
How do you compute the basis in the new property?
It is critical that you and your tax representative adjust and track basis correctly to comply with Section 1031 regulations.
Gain is deferred, but not forgiven, in a like-kind exchange. You must calculate and keep track of your basis in the new property you acquired in the exchange.
The basis of property acquired in a Section 1031 exchange is the basis of the property given up with some adjustments. This transfer of basis from the relinquished to the replacement property preserves the deferred gain for later recognition. A collateral affect is that the resulting depreciable basis is generally lower than what would otherwise be available if the replacement property were acquired in a taxable transaction.
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