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Q. What is an IRC Section 1031
Tax-Deferred Exchange?
A. If the taxpayer sells an
investment property, the taxpayer
pays tax on the recognized
gain. However, if the taxpayer
completes a 1031 exchange on that
property, it will allow the taxpayer
to exchange property on a
tax-deferred basis within a specific
statutory mandated time period. In
an exchange, the property held must
be a property held for investment or
used in a trade or business. There
will be no gain or loss recognized
in an exchange. The taxpayer must
trade even or up in value and trade
even or up in equity.
Q. Who should consider a 1031
Tax-Deferred Exchange?
A. Absolutely anyone thinking
about selling a business use or
investment property. It does not
matter if the property is large or
small or whether it is corporations
or an individual.
Q. Who should I use to facilitate a
1031 Tax-Deferred Exchange?
A. The taxpayer must use a
Qualified Intermediary (QI) to
facilitate the exchange. The QI is
an independent 3rd party
that facilitates the 1031
tax-deferred exchange. The sale of
the relinquished property and the
acquisition of the replacement
property must flow through the QI.
Q.
Why do I need a Qualified
Intermediary?
A. The Qualified Intermediary
(QI) is necessary to create the
exchange of properties required
under IRC Section 1031Tax-Deferred
Exchange. The QI simplifies the
exchange process by accepting a
transfer of your property, conveying
it to a buyer, taking custody of the
proceeds, buying the replacement
property, and transferring title to
taxpayer. This process is a very
sensitive role requiring experience,
special knowledge, and extreme care
to preserve the tax-deferred
qualifications of the transaction.
Q Can anyone serve as a Qualified
Intermediary?
A
No, there are certain "Disqualified
Persons" who can not act as your
Qualified Intermediary (QI).
Generally, these include the
taxpayer, certain relatives, or
someone who, within a two-year
period prior to your exchange, has
acted as your attorney, accountant,
banker, tax advisor, an employee,
real estate broker, or agent.
Q. How should the taxpayer select a
Qualified Intermediary?
A.
Look for legal and
accounting experience, extensive
knowledge of the 1031 tax code,
financial stability of the company,
and customer satisfaction are some
factors that the taxpayer should
consider.
Q. Does the taxpayer need a legal or
tax advisor if they select a
Qualified Intermediary?
A.
It is always a good idea for the
taxpayer to consult with their
attorney and tax advisors prior to
entering a 1031 exchange. The QI is
hired to facilitate and carry out
the tax-deferred exchange as well as
prepare the necessary documentation
for the exchange. Our company is
precluded from counseling the
taxpayer on the legality or tax
implications of an exchange.
Q. How long does the taxpayer have
to identify the replacement
property?
A.
Identification Period:
The identification of the
replacement property (or properties)
must be submitted to the QI in
writing no later than midnight of
the 45th day (including a
Saturday, Sunday, or legal holiday)
after the relinquished property is
sold. The document must give an
unambiguous description of the
property or properties, and must be
signed by the taxpayer and delivered
or sent to the QI before midnight of
the 45th day.
Q. How long does the taxpayer have
to close on the replacement
property?
A. Exchange Period:
The taxpayer must complete the
exchange on or before midnight of
the 180th day (including a Saturday,
Sunday, or legal holiday) after the
relinquished property is sold.
Q. How many properties can the
taxpayer identify?
1.
3-Property Rule: The taxpayer can
identify up to 3 properties
regardless of the fair market value
(FMV).
2.
200% Value Rule: The taxpayer can
identify more than 3 properties, but
their combined FMV cannot exceed
double or 200% of the FMV of the
relinquished property.
3.
95% Rule: If the Taxpayer fails to
comply with the three-property and
200% identification rules, his
identification will be considered
valid and any replacement property
which is identified within 45 days
and received within 180 days will
qualify, provided the Taxpayer
receives at least 95% of the value
of all of the identified properties
before the end of the Exchange
Period.
Q. What happens if the taxpayer
changes their mind about buying a
replacement property and wants to
cancel the exchange?
A.
If the taxpayer sells the
relinquished property and does not
find a replacement property, the
sale will create a taxable event and
any capital gain will be subject to
federal and state capital gains
taxes. Additionally, if the taxpayer
decides to cancel the exchange after
the QI receives the proceeds from
the sale of the relinquished
property, certain restrictions apply
to all Qualified Intermediaries that
limit access to those proceeds until
certain time periods have elapsed.
Our exchange professionals are
available to discuss those
restrictions.
Q. What happens if the taxpayer is
in escrow to sell the relinquished
property and then decides the want
to make it part of a tax-deferred
Exchange?
A.
If the taxpayer actually or
constructively received proceeds
from the sale of the relinquished
property, it is too late to enter a
1031 exchange. It is extremely
important to note the taxpayer's
intention to make this transaction
part of a tax-deferred exchange in
the contract to sell the
relinquished property. If the
taxpayer has entered into a contract
to sell, but has not closed, it may
be possible to complete a deferred
exchange, provided the taxpayer
executes the proper exchange
documents, identify the replacement
property within the 45 day
identification period, and actually
receive the replacement property
within the 180 day exchange period,
or before the taxpayers tax return
is due. Seeking the advice of your
attorney or tax advisor can help you
to make that determination.
Q. What is boot?
A.
"Boot" can be cash received from the
sale of the relinquished property or
other non-cash consideration,
including any property that is not
"like-kind," promissory notes, or
debt relief (mortgage boot). If the
taxpayer receive boot in an
exchange, it is very likely that all
or some portion of the boot will be
taxed.
Q. Do I need to do a tax-deferred
exchange for my personal residence?
A.
No, your principal residence is not
considered property held "for
productive use in a trade or
business" or "for investment," and
therefore, does not meet the
requirements of Section 1031.
However, Internal Revenue Code
Section 121 allows an individual to
exclude from taxation up to $250,000
of the capital gain realized on the
sale of the individual's principal
residence. A married couple filing
jointly can exclude up to $500,000.
Section 121 has certain requirements
that must be met.
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