1031 Like Kind Advice/Help

[Marty G.]

I have owned a property for about 4 years.  It is not my primary residence and have used it as a vacation property.  It's located in FL and the market price for the house is estimated to be $150-175k over what I paid for it 4 years ago.  I'm looking to sell as I don't want to manage (or hire a manager) any longer and be a long distance manager/investor (I'm in CT).  Instead, I'd like to sell this property and take the proceeds and roll that into a rental that's closer to me and use whatever tax advantages I can to assist me.

I'm confused with how the 1031 works and was hoping someone could explain to me how to "use" it.  My current property (that I'm considering selling) is not yet on the market and while there are other houses closer to me that I'd consider buying, I don't know how to have the 1031 work for me so not really sure how to navigate this "exchange".

I've heard so many things (and read so many variations) of how the 1031 applies, I'd like to know how it really works, specifically:

- If I sell my rental house, do I have to identify another house to purchase before I list this one?
- If not, how long do I have to identify the next property to purchase and what happens if that purchase falls through?
- If I purchase the next property, do I base the "taxable" portion on the GAIN of the house (i.e. the 150-175k in profit) or is it based on the total cost of the house?
- Lastly, I've heard that, after the sale, the money must be "untouchable" before purchasing the new property.  Is this just done via a separate bank account or does this have to be done somehow with an escrow service?

Thanks in advance... 1031 has really confused me, so appreciate the help!

[Bill Exeter]

Hi @Marty G., 

The 1031 Exchange allows you to sell your current property that is held for rental, investment or business use and defer the payment of the Federal and state capital gain, depreciation recapture and avoid the Medicare Surcharge taxes by reinvesting in other replacement property that is also owned and held as rental, investment or business use property.  

You mention vacation use.  It is held as a vacation property used solely for personal use?  If so, it would not qualify for 1031 Exchange treatment since it is used for personal use.  However, if it is used as a vacation rental then it would qualify for 1031 Exchange treatment.  

They key requirement is that the property that you sell and the property that you acquire through a 1031 Exchange must be held for rental, investment or business use.  Personal use such as a primary residence, second home or vacation property will not qualify. 

Here are the answers/comments to your questions: 

No, you do not have to identify the replacement property before you list the current house for sale.  You have 45 calendar days after the close of the sale of your current property to identify the replacement property (ies) that you intent to acquire.  There are three (3) identification rules, and you only have to comply with one of them.  

You have 45 calendar days after the close of the sale of your relinquished property to identify potential replacement property to acquire as part of your 1031 Exchange.  Your 1031 Exchange fails if you are not able to acquire any of the properties that you identified during your 45 calendar day identification period and you would pay the capital gain and depreciation recapture taxes that would have paid as if it was a regular sale.  There are no penalties for a failed 1031 Exchange other than you have to pay the taxes. 

You must trade equal or up in value based on the the sale price of the house (not the gain, profit or equity).  This means the purchase price of the new replacement properties must be equal to or greater than the sale price of our current property.  You must also reinvest all of the cash or equity that comes out of the sale of the relinquished property. 

The 1031 Exchange must be set-up through a Qualified Intermediary before the sale of your relinquished property closes.  The Qualified Intermediary or QI will hold the net proceeds from the sale of your relinquished property in order to avoid the constructive or actual receipt of the proceeds by you. The Qualified Intermediary or QI account is similar to an escrow, but does not replace the escrow.