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. There are however 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
• New investment property must be of equal or greater value.
• Equity of the new investment property must be of equal or greater value than the equity in the property being replaced.
• Debt on the new investment property must be of equal or greater value than the debt held on the property being sold unless the investor offsets lower debt on the new property being purchased by adding cash as part of the exchange.
• All of the net profit from the property being sold must be used in the purchase of the new investment property. Any cash taken out of the exchange is always considered “cash boot” and would be subject to taxation according to the investor’s taxable income.
• “Like Kind” is defined in IRC 1031(a)(1) and is very liberal about what qualifies as like kind, so the kinds of properties that can be exchanged include land, improved or unimproved, shopping centers, medical and/or office buildings, rental homes, single or multifamily, apartments, industrial and storage facilities among others.
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.
Three Property Rule – Investors are allowed to identify three properties as potential suitable replacements with no restrictions on the market value of such properties.
200 Percent Rule – Allows an investor to identify any number of properties for potential purchase/exchange so long as their cumulative value does not exceed 200% of the value of the property being sold.
95% Rule – Allows for identification of any number of properties so long as you acquire properties valued at 95% of their total or more.
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 if 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 fee’s at all but might be due at settlement. These might include insurance, taxes, repairs or maintenance and certain financing fees.
For more information including our QI suite of 24 educational videos visit www.Provident1031.com