The 1031 Exchange is an IRS Rule. It allows you to defer capital gains tax and depreciation recapture by using the proceeds from your sale of an investment property you own into a replacement property. Your 1031 exchange deferrals can be continued through as many exchanges as you wish. However, when you sell the property without reinvesting in a new property, there will be capital gains and depreciation recapture tax liability.
A 1031 Exchange must be done by a qualified Third-Party Intermediary. Before you decide to do a 1031 Exchange talk to your CPA to make sure its a right fit for you. Not talking to a professional could cause you to have dire financial issues.
It is absolutely critical to follow the requirements for 1031 exchanges to the letter in order to realize the investment benefits and avoid costly penalties.
The exchange process must be facilitated by a Qualified Intermediary (QI), the professional who actually executes the exchange. QIs hold the proceeds from the property you sell until they are reinvested in the replacement property. There must be a written “exchange agreement” between you and the QI to prevent you from having “constructive receipt” of the funds during the exchange period. The QI is required to complete a valid 1031 exchange that ensures all roles are followed and equity is preserved during the process. Using a QI as an independent third-party to facilitate a tax-deferred exchange is a safe harbor established by Treasury Regulations, and it is very important for you to select a QI before closing on the sale of your property. We can work with any authorized QI of your choice, or we can suggest one who is fully bonded and has a national reputation.
The properties involved must be “like-kind". This requirement is liberally interpreted, and virtually all real estate properties, whether raw land or those with substantial improvements, qualify as like-kind. However, REITs, real estate funds or other securities do not qualify for 1031 exchange.
• Raw Land
• Multi-Family Rentals
• Single-Family Rentals
• Retail Shopping Center
• Office Buildings
• Industrial Facilities
• Storage facilities
You must identify the exchange properties in writing within 45 calendar days of the closure for the relinquished property in accordance with one of the following rules:
Three-Property Rule: You must identify up to three properties regardless of the total value of property identified
200% Rule: You can identify any number of properties, but the combined fair market value can't exceed 200% of the relinquished investment property's fair market value
95% Rule: Identification of any number of properties regardless of the aggregate FMV, as long as at least 95% of the property is ultimately acquired. You must also close on the replacement property or properties within 180 calendar days of the closure for the relinquished property.
You must hold the properties for productive use in a business or for the purpose of investment.
The replacement property must be of equal or greater value than the property you sold.
The equity of the replacement property must be of equal or greater value than the equity of the property you sold. It is important to note that you CANNOT replace equity by acquiring more debt (with the exception of a 1033 Exchange).
The debt held by the replacement property must be of equal or greater value than the debt held by the property you sold unless you offset lower debt on the replacement property by adding cash to the exchange.
All net profit from the relinquished property must be used in the purchase of the replacement property otherwise you could have taxable consequences, sometimes known as “boot.”