Important Facts You Need to Know About the 1031 Exchange

A tax deferred 1031 Exchange is a very clear and simple process. The IRS provides specific and complete guidelines in their publication 544, which can be found on the IRS website. We also recommend you contact your tax advisor for details. If he or she has questions or concerns, we are here to assist you both and to arrange a conference call for all parties.

You may sell certain investments and defer all capital gains taxes by moving the sale proceeds into other “like kind” investment within specific time frames and following certain guidelines. In general, assets must be held for a productive use in a trade, business or as an investment, such as real estate. Properties that do not qualify for 1031 exchange include stocks, bonds, notes, partnerships and a variety of other investment types.

Properties must be exchanged solely for like kind property, meaning any real estate purchased as an investment that is expected to yield income or gain. A home purchased to live in is not considered like kind property. Like kind property includes developed or undeveloped real estate, but need not be identical in type. You can exchange a single family home for an office building, for example. The value, equity and/or debt on the replacement (purchased) property must be equal to or greater in value to the relinquished (sold) property.

You may not directly receive any funds from the sale of the relinquished property without paying capital gains taxes on those funds. If you “touch” the sale proceeds, you will be taxed. You can, however, take any portion of the sale proceeds for another purpose and simply pay capital gains tax on the proportion of gain that amount represents. The remainder of proceeds may be put through the tax deferred 1031 exchange process.

The IRS allows the investor to use a “Qualified Intermediary” (or QI) to execute the exchange, serving essentially as an escrow agent that performs the exchange within the specified timeframes and according to law. There are national and local firms who act as QIs, and attorneys will sometimes act as a QI.

From the day of the close of escrow on your relinquished property, you have 45 days to identify potential replacement property(ies). You must close on one or more of those identified properties within 180 days of the close of escrow of your relinquished property. We have never before had any issue meeting (and beating) these time frames for our investors. In fact, we strive to have your proceeds reinvested and potentially generating income for you within 2 weeks of the close of your property sale.

There are three different exchange rules that you may utilize in your exchange. You must comply with only one of the identification rules when completing the identification of your replacement properties, and we are here to advise you as needed:

• The three property identification rule limits the total number of replacement properties that you can identify to three potential properties. You could acquire one, two or all three of the identified properties as part of your 1031 exchange.
• The 200% of fair market value rule allows you to identify more than three replacement properties as long as the total fair market value of all the identified replacement properties together does not exceed 200% of the total sales value of the relinquished property.
• The 95% identification rule allows you to identify significantly more like-kind replacement properties than the first two identification rules permit. There is no limit as to the total number or value of identified like-kind replacement properties permitted under the 95% exception as long as you actually acquire and close on 95% of the value identified. This rule is difficult in execution and rarely used.