What is a 1031 Exchange?
An Internal Revenue Code (IRC) Section 1031 tax-deferred exchange is a process that allows a taxpayer to exchange qualified real property and defer the payment of capital gains tax.
To obtain the tax benefit, a qualified intermediary must be used to structure the exchange transaction. The transaction must be a like-kind exchange of property used for business, trade, or investment purposes. Real property held for resale or personal use does not qualify for a like-kind exchange.
A 1031 exchange can be a powerful tool, but there are strict rules that must be met in order to comply with IRS requirements. This information does not encompass all the applicable rules governing section 1031 exchanges. Professional legal and/or tax advisors should be consulted.
What are the benefits of a 1031 Exchange?
An exchange is one of the few tax-saving strategies available to postpone or potentially eliminate capital gains tax due on the sale of qualifying real property.
- Gain from depreciation recapture might be postponed
- Ideal for equity preservation and estate planning strategies
- Rearrange or change your investment types, such as moving from multifamily to commercial investment property
Who qualifies for a 1031 Exchange?
Individuals and tax-paying entities such as C-corporations, S-corporations, general or limited partnerships, limited liability companies, and trusts may set up an exchange of qualifying business or investment real property.
What is a Qualified Intermediary or Accommodator?
Your first decision when starting a 1031 exchange is to choose a qualified intermediary. A qualified intermediary (also referred to as “accommodator” or “exchange facilitator”) is an independent party that is used to facilitate tax-deferred exchanges pursuant to Section 1031 of the IRC.
The sale proceeds of an exchange property go to the qualified intermediary, who holds the funds until needed to acquire the replacement property. Without a qualified intermediary and an exchange agreement, the IRS may not recognize the transaction as a valid 1031 exchange.
Our skilled team of experts has a significant and diversified background in 1031 exchange transactions, so we can help you identify a strategy for your individual goals, or your client's goals and objectives, and we will assist you in choosing the most advantageous options.
What are the different types of 1031 Exchanges?
The exchange of the relinquished property and the replacement property occurs at the same time or within one day of each other.
Delayed (or Forward) Exchange:
This is the most common type of exchange. A delayed exchange occurs when there is a time gap between the transfer of the relinquished property and the acquisition of the replacement property; however, there are strict time limits, which are found in the U.S. Treasury Regulations.
This is a situation where the replacement property is acquired prior to transferring the relinquished property.
These transactions are sometimes referred to as “parking arrangements” because the exchanger cannot own both the relinquished and replacement properties at the same time. The title of the replacement property must be transferred to an exchange accommodation titleholder until the relinquished property is sold. Strict time limits apply to this type of exchange.
Build-to-Suit or Improvement Exchange:
This strategy allows the exchanger to build on, or make improvements to, the replacement property, thereby increasing its value, using exchange proceeds. Similar to the reverse exchange, an exchange accommodation titleholder must hold title to the property until improvements are made and then it’s transferred to the exchanger.
How does a standard Delayed Exchange work?
When real property being relinquished in an exchange is sold, the proceeds of the sale are provided to the qualified intermediary and placed in an FDIC insured account.
The replacement property for the exchange must be identified within 45 days of the sale date of the relinquished property. Purchase of the replacement property must be completed within 180 days of the sale date, or the due date of the taxpayer’s federal tax return for the year in which the relinquished property was transferred, whichever is earlier.
The role of Mission 1031 Exchange, as your qualified intermediary, includes preparing the required exchange agreement, assignment of contract, approving the closing statement, notifying all parties to the contracts of the assignment, and giving escrow instructions to settlement or closing agents.
How do I identify replacement properties?
There are three rules an exchanger can utilize to identify potential replacement properties. The exchanger must meet the requirements of at least one of these rules:
3 Property Rule:
The exchanger may identify up to three potential replacement properties, without regard to their value; they can acquire all, any, or partial interest of any of the three properties.
Any number of properties may be identified, but their total fair market value cannot exceed twice the value of the relinquished property. The exchanger can acquire all, any, or partial interest in any of the properties listed.
The exchanger may identify as many properties as they want, but before the end of the exchange period the exchanger must acquire replacement properties with an aggregate fair market value equal to at least 95% of the aggregate fair market value of all the identified properties.
Qualified intermediaries cannot give tax or legal advice to exchangers – consult with tax or legal professionals for additional assistance with 1031 exchanges.