1031 Exchange FAQs
Can an exchange include Seller financing?
Yes. At settlement the note must be assigned to the Qualified Intermediary and when sold, the proceeds are sent to the QI. Selling the note and utilizing the proceeds must follow the exchange’s time limits.
Can I close on my replacement property before I have a buyer for my relinquished property?
Yes. This process is known as a reverse exchange. Reverse exchanges are technically complicated. In a reverse exchange, the Exchanger cannot encumber the replacement property or the relinquished property during the process.
Can I exchange my second home?
Your second home can be exchanged only if it qualifies as an investment. As I always say – you can have only one primary residence.
Can I sell two properties and exchange them into one replacement property?
Yes. Two basic rules are critical:
1. The time period (45 day and 180 day) starts when the first of several sales closes.
2. If several sales are grouped in the same exchange, the identification rules permit listing only three properties of unlimited value or more than three properties whose values comply with the 200% identification rule.
Can I take cash out of a 1031 exchange?
You cannot take cash out without creating a taxable event. The cash you take out will be taxed at the transaction’s pro-rata rate.
Can my personal residence qualify for a 1031 exchange?
Prior to January, 2005, there was no way to avoid paying capital gains taxes with the sale of a highly appreciated primary residence. Revenue Proclamation 2005-14 provides guidance on combining the sale of your primary residence (Section 121) and Section 1031 into a non-taxable sale and exchange of property.
Does an exchange need to be simultaneous?
No, today most exchanges are delayed exchanges with 45 days to identify replacement property and an additional 135 days to close.
How do I identify properties for the Qualified Intermediary?
The essence is the identification must be "unambiguous," i.e., site specific.
How do I report my exchange to the IRS?
Form 8824 needs to be completed as part of your annual Federal return. Remember, you cannot file your tax return for the year of your exchange until you have completed your exchange.
If I purchase a DST do I have to stay in it for the entire holding period?
If an investor decides to sell his interest in property, the investment is usually first offered to the other investors. There is no need for lender approval. The purchaser must adhere to Reg D requirements and be an “Accredited Investor “. When a transfer is triggered by the death of the owner in normal estate planning, lenders always permit heirs to inherit.
What are my chances of being audited?
Currently, The IRS audits approximately 1% of all returns. The Qualified Intermediaries who must respond to audits do not see the 1031 exchange as causing the audit.
What does Form 8824 require?
Form 8824 will ask you the date you sold your relinquished property, and the date that you identified and acquired your replacement property. There is a Section for the exchanger to detail his/her recognized gain or loss and determine his new basis, a Section for Related Party Exchanges, and a Section 1043 Conflict of Interest Sales pertaining to certain officers or employees of the executive federal government branch or judicial officers of the federal government.
What is a Qualified Intermediary?
1991 Treasury Rules and Regulations provide guidance on the role of the QI and the documentation they must provide to a 1031 exchange.
The QI provides technical experience that helps to maintain the integrity of the exchange, receiving the relinquished property and funds from the Exchanger, and sending the funds for the replacement property to its Seller. A QI can’t be a related party, the Exchanger’s employee, attorney, accountant, real estate broker or investment banker. All of these relationships constitute a conflict of interest if within two years preceding transfer of the relinquished property. There is no federal agency that regulates the QI industry. Choose carefully.
What is Boot, Cash Boot and Mortgage Boot?
Boot is constructive receipt of non-like kind property. It is taxable to the extent there is a capital gain. Cash boot is cash constructively received. Mortgage boot is when the replacement property has less debt than the relinquished property, and additional cash has not replaced the debt deficiency. The Exchanger pays taxes on cash and mortgage boot.
What is Like Kind property?
Like kind property, provided it is held for investment, can include commercial, single family rental properties, raw land, apartments, industrial properties and a lease hold interest of 30 years or more. If the state in which you reside considers timber and mineral rights real and not personal property, they too are like kind.
When is a 1031 exchange applicable?
Whenever a property owner intends to sell any property that is not his personal residence (unless complying with Revenue Proclamation 2005-14) or not property that is held for "sale" with plans to buy another like kind property within 180 days.
Where does the deposit go? Where does the money go?
The contract deposit goes to the Qualified Intermediary (QI). The Exchanger never receives the money. At settlement the Seller’s net proceeds are wired to the QI and placed into a separate interest bearing account. At the closing of the replacement property, the funds required to close the transaction will be wired from the exchange account held by the QI.
Who is a related party?
A related party is an Exchanger’s spouse, siblings, descendants or ancestors; two corporations that are members of the same control group; a grantor or fiduciary of any trust; or a related C or S corporation or partnership in which there is more than 50% ownership or controlling interest.
Why exchange property instead of just selling it?
The astute investor uses all of his equity to acquire another property, instead of only the amount left over after paying Federal and State income taxes on gain.