What is a 1031 Exchange?

What is an exchange?

What is like-kind property?

What are TIC’s, or fractional ownership programs?

What if more than like-kind property is exchanged in the transaction?

What is fair market value?

What constitutes disposition?
 

1031 Exchange FAQ
 
 
 
 
 

What is an Exchange?

To qualify for a 1031 Tax Exchange and defer tax payment, the transaction must take the form of an exchange rather than a simple purchase and sale. For real estate, 1031 Tax Exchanges are usually done through title companies or accommodators that specialize in 1031 Tax Exchanges. These companies act on behalf of the buyer and seller by functioning as an independent third party that holds each party’s assets until all requirements of the transaction have been completed. Using one of these methods to facilitate the transaction enables the taxpayer to “exchange” property without first receiving the proceeds from sale and thus “realizing” a gain.

Accommodators and title companies not only help facilitate the 1031 Tax Exchange transaction but can also help identify it. It is rare to find two individuals that are willing to 1031 Tax Exchange properties with one another.

Most times there are multiple parties involved in a 1031 Tax Exchange and these companies’ help coordinate the transaction. Often times there is one property seller that needs cash, one buyer with cash, and one taxpayer looking for a 1031 Tax Exchange. With the help of an accommodator, the transaction could play out as follows…

John owns a small 8-plex apartment complex that he purchased four years ago for $300,000. Matt offers to buy Johns’ apartment complex for $400,000, but John does not want to recognize $100,000 in capital gain ($400,000- $300,000). John would rather 1031 Tax Exchange his apartment complex with Peter for his retail center (worth $400,000). Peter, on the other hand, is in need of cash and does not want to trade for an apartment complex. With the help of an accommodator, Matt purchases Peters’ retail center for $400,000, and Peter gets his cash. Matt then turns around and 1031 Tax Exchanges the retail center for Johns’ apartment complex. John gets his 1031 Tax Deferred Exchange and Peters’ retail center, while Matt gets Johns’ apartment complex.

When using an accommodator or title company, the new property being acquired in a 1031 Exchange must usually be identified within 45 days of the disposition of the old property. In order to formally identify the property to be transferred in a 1031 Tax Deferred Exchange, the transaction typically is detailed in writing and signed by all parties. Although this formal process is well documented, taxpayers frequently change their minds and substitute other properties before the end of the 45 day period. The new property being acquired in a 1031 Tax Exchange must also be received within 180 days of the disposition of the old property.

Property must be held for investment purposes or for the productive use in a trade or business for a 1031 Tax Exchange

Most real estate income producing properties qualify under this category. Generally, in a 1031 Tax Exchange transaction the property being transferred must have been acquired for the intent to generate income from its rents, and or for the gain from expected appreciation. Personal residences and vacation homes not held for investment do not qualify for a 1031 Tax Deferred Exchange.

There are more specific rules regarding the qualification of property for 1031 Tax Exchange purposes. For more information on 1031 Tax Exchanges consult a tax professional.
 

WHAT IS A REVERSE 1031 TAX EXCHANGE?

A Reverse 1031 Tax Exchange is when the exchanger purchases their new replacement property before they have sold their old property.  The IRS has adopted regulations specifically to allow Reverse 1031 Tax Exchanges.  The Reverse 1031 Tax Exchange receives basically the same tax benefits as a regular 1031 Tax Exchange. To make the Reverse 1031 Tax Exchange work, someone other that yourself (usually your Qualified Intermediary) must take title to one of the properties until you are ready to convey your old property to a buyer. 

What is a Safe Harbor Reverse 1031 Tax Exchange?

A Safe Harbor Reverse 1031Tax Exchange involves the accommodator temporarily holding the new property for the exchanger until the old property is sold. Within 45 days of this arrangement, the exchanger must identify this new property as being the replacement 1031 Tax Exchange property. The exchanger also has 180 days to complete the 1031 Tax Exchange transaction in order for it to be regarded as safe harbor. This safe harbor method of structuring a Reverse 1031 Tax Exchange is outlined in the 2000 IRS guidelines. This is viewed as the safest way to structure a Reverse 1031 Tax Exchange because it is clear that the exchanger does not receive any property prior to completing the transaction.

What is a Traditional Reverse 1031 Tax Exchange?

A traditional Reverse 1031 Tax Exchange is structured the same way as a safe harbor Reverse 1031 Tax Exchange except that the exchanger cannot meet the 180 day time requirement. This is usually due to the exchanger having difficulty selling their old property. When this is the case, make sure that your tax advisor takes the proper precautionary measures to document and insure the integrity of your Reverse 1031 Tax Exchange.

What is a Construction Reverse 1031 Tax Exchange?

A Construction Reverse 1031 Tax Exchange allows a taxpayer to acquire a piece of raw land for future development before selling their old property in a 1031 Tax Exchange. Construction Reverse 1031 Tax Exchanges are structured in the same way as traditional and Safe Harbor Reverse 1031 Tax Exchanges. In a Construction Reverse 1031 Tax Exchange the accommodator temporarily holds the land for the exchanger until the old property is sold.  Once the old property is disposed of the exchanger can begin to build on the new land.

What is a 1031 Starker Exchange?

A 1031 Starker Exchange is just another word for a Reverse 1031 Tax Exchange.  A 1031 Starker Exchange allows an owner of investment property to postpone the payment of capital gains taxes and depreciation recapture taxes on the sale of their property. They are allowed to defer these tax payments only if they reinvest the proceeds from the sale into another like kind property.

A Starker Exchange is a 1031 Tax Exchange in which the taxpayer purchases their replacement property before they sell their old property. This is the most commonly used type of 1031 Tax Exchange and is specifically allowed by the IRS through a statutory amendment (Tax Reform Act of 1984). These exchanges are known as "Starker" exchanges because of the name of the litigant in the case that determined the law.

 What is a 1031 Tic Exchange?

A 1031 Tic Exchange, or a 1031 Tenants in Common Exchange, allows an investor to exchange their property for a fractional share in another property. Instead of exchanging your property with another property of similar size, an investor can exchange their property for a fractional share of a large institutional grade real estate asset. 1031 Tic Sponsors are companies that specialize in arranging these transactions. For an investor, these transactions offer every advantage that a traditional 1031 Tax Exchange offers and more. They are large in size and can easily withstand fluctuations in the economy or market, they are typically managed by a professional property management company, and they typically come already packaged up with financing and insurance. For an investor, these transactions take almost all of the work out of owning rental property.

What is a 721 Exchange?

Like a 1031 Exchange, a 721 Exchange is an effective vehicle for deferring capital gains taxes. A 1031 Exchange allows an investor to sell their  investment property and reinvest in another like kind property while deferring capital gains taxes. Under a 721 Exchange, an investor can sell their property to a partnership in exchange for shares or ownership in that partnership and defer paying capital gains taxes.

 

 
 
   
   
 

Please be advised that any discussion of U.S. tax matters contained within this communication is not intended or written to be used and cannot be used for the purpose of (i) avoiding U.S. tax related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This communication is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial product. Therefore, we do not represent that this information is complete or accurate and it should not be relied upon as such. All information is subject to change without notice.
   
  Copyright © Exchange Reality.