1031 Tax Deferred Exchange
A 1031 Tax-Deferred Exchange is a transaction that allows owners to receive the full value of their investment property. A 1031 exchange allows owners who decide to dispose of their investment property to do so and avoid paying capital gains taxes by being able to reinvest their sales proceeds into “similar” properties.
The general rules for a 1031 exchange are pretty simple. Any type of property (real or personal) may be exchanged provided the property given up was previously held for investment purposes. In most cases, personal residency does not qualify as a tax-advantaged exchange.
- LIKE ART The replacement property must be “of the same kind” as the property given up. “Same” does not mean exactly the same thing. Most properties are considered “similar” to other properties, such as B. Exchanging a single-family home for a condominium, warehouse or office building.
- PROPERTY VALUE As a rule of thumb, the property you purchase must have both value and equity equal to or greater than the property you are giving up.
- IDENTIFICATION PERIOD – The property to be purchased must be identified within 45 days of the closure of the abandoned property. Property identification rules include:
- Three (3) OWNERSHIP RULE: Up to three (3) properties can be identified, regardless of their value,
- OR 200 PERCENT RULE: Any number of properties can be identified as long as their combined market value is no more than twice the abandoned property
- OR 95 PERCENT RULE: Any number of properties can be identified, regardless of their combined market value, as long as you acquire 95% of that total value.
- EXCHANGE PERIOD – Acquisition of the new property must be completed within 180 days of the transfer of the abandoned property or by the tax return filing date for the year in which the first property was transferred, whichever occurs first. These time restrictions must be strict followed for the exchange to be approved by the IRS. The tax office Not grant extensions.
- STEPS FOR A SUCCESSFUL EXCHANGE
- Purchase contract. A contract for the purchase and sale of the provided property is concluded between the buyer and the seller. The sales contract should include a “cooperation clause” in which the buyer agrees to cooperate with the seller in structuring and executing a 1031 exchange. The seller (or buyer) will assign its interest in the arrangement to an agent or a qualified agent (FAC or QI).
- Exchange open. The exchange is usually set up with the FAC or QI after an escrow account has been opened to complete the sale. Subsequently, the necessary documents for influencing the exchange should be prepared. The exchange agreement (between the taxpayer and the FAC or QI) defines the exchange transaction and sets out the obligations of both the taxpayer and the FAC or QI. An assignment of the abandoned property purchase agreement to FAC or QI is being prepared, whereby the rights as seller will be transferred to FAC or QI.
- Closure of Abandoned Property. Abandoned ownership ends when all terms of sale are met and ownership is transferred to the buyer. While the transfer is direct from seller to buyer, it constitutes a transfer from seller to the FAC or QI in exchange for other property received at a later date. Proceeds from the sale are delivered directly to the FAC or QI for the replacement property. At no time shall the seller be in the process of actual or factual receipt of the cash proceeds.
- Identification of Substitute Objects. The period for identifying the property(s) to be acquired as replacement property begins upon the closure of the abandoned property. Forty-five (45) days from the date of transfer is allowed to identify the purchased property.
- Purchase agreement for replacement property. After the identification of a suitable “like kind” replacement object and a decision as to which object is to be purchased, a sales contract is concluded with the seller. The object must be one or more of the objects identified by the end of the 45-day identification period.
- Exchange documentation for the commercial property. The assignment of the purchase contract for the replacement object and the release and warranty to be carried out by the buyer and seller must then be prepared. In addition, instructions should be prepared for the settlement agent detailing the elements required to complete the exchange.
- Closing of the replacement property. If the closing conditions are met, the FAC or QI should deliver the funds it is holding to the Settlement Agent to purchase the replacement property. The seller will transfer the replacement property directly to the buyer. Closing of the replacement property must occur within 180 days of the transfer of the relinquished property (or by the tax return due date, if earlier) for the transaction to qualify for section 1031 treatment.