Understanding 1031 Exchanges
Each 1031 Exchange transaction is unique; this resource contains a sampling of general inquiries and is for informational purposes only. For more in depth 1031 information please consult your tax advisor, qualified intermediary, or attorney.
What are 1031 Exchanges?
A 1031 Exchange is a method of deferring capital gains taxes when selling an investment property and purchasing a similar like-kind investment property. Like-kind properties do not have to produce income, but they must be investment properties. 1031 Exchanges do not apply to inventory, stocks, bonds, notes, securities, etc. Like-kind properties are similar in nature or character even if they are different in quality.
How can I begin the 1031 Exchange process?
You may visit the IRS website: http://www.irs.gov/ and research 1031 or like-kind exchanges. There will be an online form as well as additional contact information and resources.
Will the IRS provide an extension on a 1031 Exchange?
The IRS currently does not issue extensions to the 45 or 180-day rule. However, if your tax return is due and you are within your exchange period you may file for a tax return extension in order to complete your exchange.
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How can I choose a replacement property?
A property owner is required to submit (in writing) a list of replacement property selections. Owners may 1. Choose as many properties as they wish as long as the aggregate value does not exceed 200% of relinquished property, or 2. Choose three properties without consideration of price.
How many properties can I buy in one exchange? How many can I sell?
You may purchase as many properties as you can afford (and close) and you may sell as many properties as you can afford (and close) within the same period of time. This period of time is defined by the closing of the first sale.
Can proceeds from a 1031 Exchange be used for something other than property?
Proceeds used for purchasing anything other than investment/replacement property will be taxable. Proceeds removed from exchange (escrow) during an exchange process could jeopardize an entire 1031 Exchange.
Can I buy a replacement property before selling a relinquished one?
This is considered a reverse exchange. It is best to consult a professional due to the complexity of this type of transaction.
How is ‘gain' calculated?
Begin with the purchase price of your property, subtract depreciation (if any) and add capital improvements. The sum is an adjusted basis. Subtract the adjusted basis and the new sale cost from the new sales price and the remaining amount is considered gain.
If I live on/in any part of my property can it still be exchanged?
A portion of your property can be exchanged if it considered investment property. Multi-family properties, farms, and ranches are examples.
What happens if I buy down during an exchange?
If the value of new property is less (buy down), or you exchange to defer a portion of your transaction you will pay taxes on the proceeds at the close of the transaction. Closing costs may offset the differential.
Can a vacation home or second home be exchanged?
There are strict rules governing the use of vacation homes for deference. If a property has been rented while under ownership, or you have not used the property for personal means, you may be able to claim it as an investment.
Can water or timber rights qualify for exchange?
Timber rights (if held for one year or more) can be exchanged for timber rights. If timber has not been removed from a property it may qualify as real property and may be exchanged for other types of investment property. As a general rule timber rights acquired by deed (as opposed to bill of sale or assignment) are usually considered real property.
State laws govern water rights.If real property holds water rights and is also considered an investment property then water rights may be exchangeable. It is best to speak with your attorney about exchanges of this nature. Please note, rulings on timber and water rights differ by state.
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Can I improve on property I already own?
Real property cannot be traded for improvement(s); they are not like-kind. In addition, if you own both properties there can be no trade.
Do I need a qualified intermediary?
The IRS highly recommends the use of an intermediary during a 1031 Exchange.
Can I borrow money from an exchange? Can I receive interest on funds if I don't borrow them?
Funds may be disbursed at the close of the sale by instructing escrow, however, no funds may be disbursed once they have reached or are being held by a qualified intermediary. If interest accrues while funds are being held and the interest is disbursed prior to completing an exchange, then the funds are considered taxable.
Can funds be advanced to cover fees/costs associated with acquiring replacement property?
If a qualified intermediary is named in a transaction then funds may be disbursed to escrow to cover earnest money or related expenses such as appraisals. If funds have been advanced, the exchanger may be eligible for reimbursement at the close of escrow without incurring additional fees or taxes.
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