Is it time to recognize investment gains in your real estate portfolio?
In general, a “1031 Exchange” refers to the Internal Revenue code section 1031 that offers
a real estate investor or trade or business owner the opportunity to defer ALL their
capital gains tax owed from the sale of an investment or trade or business property.
Here are the basic rules:
1. To take a 100% deferral of the Capital Gains tax, the Investor (also known as the Exchanger)
has to reinvest ALL the equity and debt from the sale of the property into another investment
property of equal or more value.
2. The property the Investor/Exchanger sells is called the Relinquished Property.
3. The property the Investor/Exchanger buys with the proceeds is called Replacement Property.
4. To avoid issues about the validity of handling the exchange, the option that is most frequently
used is for the Exchanger to hire a third party known as a Qualified Intermediary
(also known as a Q.I., Accommodator or Facilitator) to do the necessary
paperwork for both transactions, hold the proceeds in an escrow account and make such funds
available for the purchase of the new property.
5. Both the Relinquished and Replacement properties have to be investments or used in a trade
or business. For 1031 Exchanges dealing with real estate (they can be used for other property),
the real estate can be land or an improved property. If the property is an improved property,
then there should be either a rental history or at least a legitimate attempt to rent it out
or use it in a trade or business. A primary residential home or “flipped” properties are not eligible.
6. The Exchanger is bound by a strict time line to close on both transactions:
a. The Exchanger has 45 calendar days from the close of escrow on the Relinquished Property
to provide written identification to the Intermediary of up to three properties he/she is
considering buying as a Replacement Property. If the Exchanger needs to identify
more than three properties, additional restrictions apply.
b. The Exchanger has 180 calendar days from the close of escrow on the Relinquished Property
to close escrow on whichever identified property(ies) are to be used as
the Replacement Property.
7. At the closing of the Relinquished Property the Exchanger and Intermediary sign a
“Like-Kind Exchange Agreement”. This establishes their relationship. The Exchanger and
Intermediary sign an “Escrow Instructions” document, defining the handling
of the escrow. The Exchanger and Buyer sign an Assignment of Contract, which assigns the
contract to the Intermediary. When the Relinquished Property closes, the proceeds are wired
to the escrow account of the Intermediary. It is on this transaction that the Intermediary
usually collects their fee.
8. When the Exchanger sets up the closing on the Replacement Property, the Intermediary
coordinates with the closing agent to wire the money for the closing and send the necessary
documents for the closing.
9. There are other types of exchanges including a Reverse, Simultaneous, Aircraft/Business
and Improvement Exchanges.
I recommend that any tax payer considering a 1031 exchange should first consult their tax
professional to discuss their specific individual situation. I will work in conjunction with
your tax professional to help guide you through the process.
identification to the Intermediary of up to three properties he/she is considering buying as a
Replacement Property. If the Exchanger needs to identify more than three properties,
additional restrictions apply.
Please call me for more information on 1031 exchanges and let’s figure out the best strategy for you!