1031 Basics ...
What's it all about anyway?
Okay, we promise to keep it simple.
Below we have ten basic questions and answers that should help you quickly understand at least the basics of 1031 Tax Exchanges.
It just takes a few minutes to get up-to-date on this unique transaction.
Of course there are lots more details and considerations where a professional 1031 expert like FORT Properties can walk you through the potential pitfalls.
But start below. Then if you still have questions, give them a call at 213-572-0222.
Q:
Where does the 1031 term come from and what is it?
Where does the 1031 term come from and what is it?A:Section 1031 of the IRS’ Internal Revenue Code defines a property transaction called a tax deferred exchange. Hence the term 1031 tax exchange.
Section 1031 of the IRS’ Internal Revenue Code defines a property transaction called a tax deferred exchange. Hence the term 1031 tax exchange.It offers investors a great opportunity to build wealth by deferring taxes.
Q:How does it work?
How does it work?A:An investor may dispose (sell) off their current investment property (called “relinquished property”), use their equity to acquire replacement property, and obtain leverage in an amount equal or greater to the leverage that was on the relinquished property, and by doing so completely defer their capital gains tax that would have been due with the sale.
An investor may dispose (sell) off their current investment property (called “relinquished property”), use their equity to acquire replacement property, and obtain leverage in an amount equal or greater to the leverage that was on the relinquished property, and by doing so completely defer their capital gains tax that would have been due with the sale. Q:So how can I defer capital gains tax?
So how can I defer capital gains tax?A:Two requirements must be met to defer capital gains tax that would have been due with the sale of the relinquished property:
Two requirements must be met to defer capital gains tax that would have been due with the sale of the relinquished property: 1. The new Replacement property must be “like-kind”.
2. The exchanger cannot receive cash or other benefits (called “boot”)
Q:Are their timing requirements that must be met?
Are their timing requirements that must be met?A:Yes. Exchanges must be completed within strict time limits.
Yes. Exchanges must be completed within strict time limits. First, the investor contemplating a 1031 exchange must enter the exchange transaction prior to the disposition of the relinquished property.
Second, an exchanger has 45 calendar days from the date the disposition/sale of the relinquished property closes to properly “identify” replacement properties.
Lastly, the purchase of replacement properties must be completed within 180 calendar days after the disposition/sale of the relinquished property.
Q:So how does one start this 1031 transaction?
So how does one start this 1031 transaction?A:An exchanger and a Qualified Intermediary execute an Exchange Agreement.
An exchanger and a Qualified Intermediary execute an Exchange Agreement.This solves the two IRS stipulations by
1. Requiring the Qualified Intermediary to essentially acquire the relinquished property from the exchanger and transfer it to the buyer of the relinquished property by direct deeding. Then it’s also required that the Qualified Intermediary acquire the replacement property from the seller and transfer it to the exchanger by direct deeding.
2. Requiring all cash and other proceeds (used to purchase the replacement property) from the relinquished property disposition to be assigned to and held by the Qualified Intermediary in a separate account.
Q:Is the Qualified Intermediary optional or required?
Is the Qualified Intermediary optional or required?A:Absolutely required. The IRS requires the use of this third party to ensure certain things happen.
Absolutely required. The IRS requires the use of this third party to ensure certain things happen.Specifically, the IRS stipulates that:
a) an actual exchange must take place in every transaction, and
b) if an exchanger either actually or constructively receives proceeds from the sale of the relinquished property then those proceeds are taxable as "boot".
Q:Can I contact a Qualified Intermediary directly? Or do I need someone like FORT Properties?
Can I contact a Qualified Intermediary directly? Or do I need someone like FORT Properties?A:Yes. You may contact a Qualified Intermediary directly and we are happy to provide recommendations. FORT Properties is not a Qualified Intermediary. FORT Properties provides exchangers a replacement property option through their TIC/Tenant-in-Common offerings.
Yes. You may contact a Qualified Intermediary directly and we are happy to provide recommendations. FORT Properties is not a Qualified Intermediary. FORT Properties provides exchangers a replacement property option through their TIC/Tenant-in-Common offerings.Q:What other requirements are there?
What other requirements are there?A:There are three basic rules if you wish to completely defer any capital gains taxes when completing a 1031 exchange. An exchanger must:
There are three basic rules if you wish to completely defer any capital gains taxes when completing a 1031 exchange. An exchanger must: 1. purchase replacement properties that have an aggregate value equal or greater than the relinquished property
2. Invest all of the relinquished property equity into the replacement properties
3. Obtain replacement property debt equal or greater than debt that was on the relinquished property.
Q:Are there any things not allowed during this exchange?
Are there any things not allowed during this exchange?A:Yes. An exchanger cannot exchange property that is their principal residence or second home. He must exchange property that is held for income or investment purposes. Also he must acquire replacement properties that will also be held for income or investment purposes.
Yes. An exchanger cannot exchange property that is their principal residence or second home. He must exchange property that is held for income or investment purposes. Also he must acquire replacement properties that will also be held for income or investment purposes.Also Section 1031 DOES NOT apply to exchanges of stocks, bonds, notes, inventory or interests in a partnership.
Q:Are there other good reasons to do a 1031 exchange besides deferring tax?
Are there other good reasons to do a 1031 exchange besides deferring tax?A:For sure. There are a myriad of additional motives for completing an exchange.
For sure. There are a myriad of additional motives for completing an exchange.Here’s several:
- Exchange into a higher value property that provides additional depreciation benefits for the investor/owner.
- Exchange from non-income producing land to income-producing property
- Exchange into a property or properties located in rapidly appreciating markets
- Exchange into non-management intensive property or properties that provide the opportunity for the investor to be passive. This includes Tenants-in-Common (TIC) properties.
- Exchange from several smaller properties into a larger investment property
- Exchange from a larger property into several smaller properties or TIC properties for estate planning purposes.
- Exchange from a partial interest in a property to a fee interest in another
- Exchange from a fee interest in a non-institutional smaller property into an institutional quality T-I-C property.
Ten Questions about 1031's for the Novice Investor
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