In other words, a properly structured 1031 exchange
allows an investor to sell a property and defer
all capital gains taxes so long as they reinvest
the proceeds in a new property within a clearly
defined time frame.
You can defer all capital gain on your transaction
by doing all of the following:
- purchasing property that is equal to or greater
in value than your relinquished property;
- reinvesting
all of the net equity from your relinquished
property in the replacement property; and
- acquiring debt on the replacement property
that is equal to or greater than the debt on
your relinquished property (debt on the replacement
property may be offset by contributing an equivalent
amount of additional cash)
You can also complete a partial exchange, but this
will incur tax liability on the non-qualifying portion.
Types of properties that qualify.
The investor (Exchanger) must sell property that
is held for income or investment
purposes and acquire "like-kind" replacement
property that will be held for income or
investment purposes. The term "like-kind"
is sometimes misinterpreted to mean "identical"
- but this is not the case. In fact any real property
can generally be exchanged for other real property.
Examples of qualifying exchange properties include:
- Bare land exchanged for Rental property
- A single family rental exchanged for Industrial
property
- A rental cabin in Taos exchanged for a doctor's
own office in San Diego
- Bare land exchanged for a Tenancy-In-Common
(TIC) interest in a shopping center
As you can see, there are really few limitations
on what constitutes "like kind".
Some examples of properties which do not qualify
for exchange purposes include:
- Bonds, Stocks (including REITs), and Notes
- Interests in a Partnership
- Trust Deeds
- Stock in Trade (including Real Estate held
as Stock in Trade)
The 45 and 180 day rules.
Identification Period:
The Exchanger must identify the Replacement Property
within 45 days of the transfer of the Relinquished
Property. The Exchanger can identify more than
one possible Replacement property using one of
three options:
- The three property rule -
You may identify up to three replacement properties
regardless of their fair market value. It is
not necessary to purchase all of the identified
properties. (Even if you intend to buy only
one replacement property, it is advisable to
identify one or two alternate properties in
case the first property purchase falls through.)
This is the most common rule utilized.
- The 200% rule - If more than
three properties are identified, their combined
fair market values cannot exceed twice the fair
market value of the property being disposed
of.
- The 95% exception - If more
than three properties have been identified,
and their total fair market value exceeds 200%
of the value of what was sold, the exchange
may still be valid if 95 % of the total cost
of all properties on the list are purchased.
This means that if the properties on your list
have a total combined cost of (for example)
$1,000,000, then you must purchase at least
$950,000 of them.
Exchange Period: The
Exchanger must complete the 1031 exchange transaction,
which includes the receipt of title to all of
their intended replacement properties, by the
earlier of:
(a) the 180th calendar day after the Exchanger
has transferred title to his or her first relinquished
property to the buyer, OR
(b) the due date of the Exchanger's Federal
income tax return for the tax year in which
the relinquished property was sold, including
extensions of time to file.
Exchangers do not have to worry about part (b)
above unless their first relinquished property
transaction closes on or after October 17th of
any given tax year. Exchangers that have 1031
exchange transactions closing on or after October
17th will have fewer than 180 calendar days to
complete their 1031 exchange transaction, unless
they file for an extension of time to file their
federal and, as necessary, state income tax returns.
Once the extensions of time have been filed, the
Exchanger must complete their 1031 exchange transaction
within the 180 calendar days before they actually
file their Federal and, if applicable, state income
tax returns.
The Exchange
Deadline Tool can help you determine
your 45 and 180 day expirations.
