A 1031 exchange is a tax deferred sale and purchase of properties that are like-kind for the benefit of deferred gain treatment. When must the investor decide to complete an exchange?
The decision to exchange must be made prior to closing of the relinquished property. The exchange agreement must be in place and delivered to all parties before the relinquished property transfer of title.
Can the proceeds from the sale of the relinquished property simply be held in escrow at closing?
The proceeds from the sale of the relinquished property should be delivered to a “qualified intermediary”. The proceeds cannot be held in escrow, unless the escrow account in question is either a “qualified escrow account” or a “qualified trust account” and not subject to the control of the investor. Any control by the investor is considered to be constructive receipt and is boot.
What is the 45-day Identification Period and when does it begin?
Section 1031 requires that the replacement property be identified within 45 days of closing on the relinquished property. This identification period is strictly enforced and violation will defeat the tax deferral.
What is the 180-day exchange period and when does it begin?
Section 1031 requires the replacement property be purchased within 180 days of closing on the relinquished property OR the date the taxpayer’s tax return is due, whichever date is first. The purchase date is considered to be the closing date. Note that for tax return due dates that fall before the 180 days, a tax return extension can be filed. However, a taxpayer can never amend their return for extension purposes.
Is there an extension allowed to either the 45-day period or the 180 period?
The IRS does not allow extensions for either the 45-day period or the 180-day period.
If the exchangor’s 45th or 180th day falls on a weekend or holiday do I get the benefit of the following business day?
No. The IRS calculates this timeline based on calendar days. There are no extensions given.
When is a 1031 exchange considered completed?
A 1031 exchange is considered complete once the exchangor has acquired title to all of the identified replacement property(s) to which the exchangor is entitled, within 180 days.
Does vacant land qualify as like-kind property?
Yes, vacant land is like kind with all other types of real property. However, like other properties, in order to qualify for a 1031 Exchange, the land must be held for productive use in a trade or business or for investment.
If the relinquished property is classified as residential income property, does the replacement property need to be residential income property?
No. The like-kind requirement does not limit the type of real property acquired in an exchange. You may exchange residential income property for commercial property, commercial property for industrial property and vacant land for residential income property. Any combination of properties may be exchanged. Again, any property involved in an exchange must be held for productive use in a trade or business or for investment.
What are the requirements for deferring tax on a capital gain?
In order to defer all of the tax on the sale of investment property, first make sure that the relinquished and replacement properties are “like kind” and held for productive use in a trade or business or for investment. Second, make sure that the timelines for the exchange are met. Third, make sure that all of the proceeds generated by the sale of the relinquished property are used in the purchase of the replacement property and that the FMV of the replacement property is equal to or greater than sale price of the relinquished property. If any of the first two requirements listed are not met, no exchange is possible. If any of the third requirement is not met, a taxpayer may be able to partially defer their gain but not wholly.
Am I required to have a mortgage on the replacement property?
No. To avoid mortgage boot on the net debt relief, the replacement property financing should include debt equal to or greater than the debt on the relinquished property. If the investor wishes to reduce their overall debt, they may contribute cash out of pocket to the purchase of the replacement property. Cash contributions by the investor serve to offset net debt relief.
I have identified my Replacement Property but have not sold my investment property. Can I still do a 1031 exchange?
Yes. Reverse exchanges are recognized by the IRS and can be accomplished by the intermediary acquiring title to one of the exchange properties. Reverse exchanges are often complex transactions. Please feel free to contact us to discuss the issue in more depth.
Do I need to amend my sale and purchase contracts when conducting a 1031 Exchange? Does my Realtor need to mention the 1031 Exchange on the MLS listing of my property?
No. Tax law does not require amending sales or purchase contracts nor does it require amending MLS property listings.
However, in order to complete an exchange, both parties to the sales and purchase contract must agree to an assignment of contract rights from the exchanging party to the qualified intermediary. Although the assignment of rights does NOT effect the party not involved in the exchange, both parties still must agree to the assignment of contract rights from exchangor to intermediary. In order to prevent any surprises at closing, it is probably wise to insert language into the sales and purchase contracts that stipulate the transaction involves an exchange. Inserting language into the MLS listing does not create a contractual obligation and therefore does not add any security to the exchange.
The following is proposed language to include in contracts involving 1031 Exchange. There is first sample language for the sale of the relinquished property and then sample language for the purchase of replacement property.
Please note, the following language is a sample only and should not be considered legal advice. Please consult tax counsel for specific language.
Buyer is aware that Seller is to perform an IRC 1031 tax deferred exchange. Seller requests buyers cooperation in such an exchange, and agrees to hold Buyer harmless from any and all claims, liabilities, costs, or delays in time resulting from such an exchange.
Seller is aware that Buyer is to perform an IRC 1031 tax deferred exchange. Buyer requests Sellers cooperation in such an exchange, and agrees to hold Seller harmless from any and all claims, liabilities, costs, or delays in time resulting from such an exchange.
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