1031 Basics
Q. Why would someone want to do a 1031 Exchange? ( Back to Top )
To defer capital gains tax on the sale of commercial, business, or investment property.
Q. Is a 1031 Exchange a gimmick or loophole in the Internal Revenue Code?
No. Section 1031 has been a part of the Internal Revenue Code since the inception of the Code, during the 1920’s.
Q. What type of property is not eligible for a 1031 Exchange?
Your residence is not eligible for 1031 treatment. Any other property that is not held for commercial, business, or investment
purposes is also not eligible.
Q. Is 1031 only for capital gains?
No. Section 1031 applies to capital gains taxes (15%), depreciation recapture (25%),
and state income taxes (generally 8% to 9% where applicable). Long-term capital gains taxes apply to property held over
1 year – gains from property held less than a year are typically taxed as ordinary income.
Q. How do I start a 1031 Exchange?
You must contact a Qualified Intermediary before you sell your property, so that you can complete the appropriate
documentation and structure the exchange.
Qualified Intermediary ( Back to Top )
Q. Do I have to use a Qualified Intermediary?
Using a Qualified Intermediary is the most common way to receive "safe harbor" protection for your 1031 Exchange.
Q. Can’t my own attorney or CPA serve as my Qualified Intermediary?
No. A Qualified Intermediary must remain completely independent and cannot have been your agent in the past 2 years.
1031 Timeframes ( Back to Top )
Q. Do I have to know what property I will be purchasing when I start the exchange?
No. You have 45 days from the sale of your relinquished property to identify your potential replacement properties.
Q. How long do I have to purchase my replacement property?
You have 180 days from the sale of your relinquished property by which you must close on the purchase of your replacement property/properties.
Q. What happens if my 45th or 180th day falls on a Saturday, Sunday, or holiday? Are there any extensions to these dates?
As a general principle, there are no extensions for either the 45- or the 180-day rules. However, the IRS has the authority to provide
an extension to these deadlines. Recent examples of such extensions include the terrorist attacks of September 11, 2001
and recent hurricanes.
Property Identification ( Back to Top )
Q. How many potential replacement properties may I identify?
• 3-property rule: You may identify up to 3 properties without regard to their value.
• 200% rule: You may identify more than 3 properties provided that their combined fair market value does
not exceed 200% of value of the relinquished property.
• 95% rule: You may identify any number of properties, provided that you acquire 95% of the fair market value of those properties.
The Napkin Rule ( Back to Top )
Q. Do I have to acquire a property of equal or greater value?
Yes, in order to completely defer the applicable capital gains tax. To the extent you purchase a property of lesser value,
you will be taxed on the difference. (See Napkin Rule)
Q. Do I have to use all the cash proceeds from my sale on my purchase?
Yes, you must use all cash proceeds from the transaction in order to completely defer the applicable capital gains tax.
To the extent you do not use all your proceeds on the purchase, you will be responsible for any tax on the difference.
Construction Exchanges ( Back to Top )
Q. May I purchase replacement property that is not yet built?
Yes, you may purchase replacement property that is not yet built, provided that the improvements on the property are completed
prior to the expiration of the 180 days. This is a Construction Exchange with greater complexity and fees. In a Construction Exchange,
the property is held by a specially formed LLC called the EAT (Exchange Accommodation Taxpayer).
Reverse Exchanges ( Back to Top )
Q. May I purchase replacement property before I sell the property that I own?
Yes. This is a Reverse Exchange and has greater complexity and fees. Reverse Exchanges must be initiated before you purchase
the replacement property. Again, the property is held by an EAT (Exchange Accommodation Taxpayer).
Tax Deferrals vs Tax Savings ( Back to Top )
Q. Is a 1031 Exchange tax-free?
A 1031 exchange defers taxes; it generally does not eliminate them. The replacement property will carry the tax basis of the
relinquished property – which means that upon the sale of the replacement property all tax will be due or the taxpayer can enter
into another 1031 exchange.
Q. How can deferral turn into savings?
If the replacement property is purchased with investment intent, and later converted to a personal residence, the taxpayer may
receive Section 121 exemption from a certain amount of taxes ($250,000 for an individual or $500,000 for a married couple).
Again, to gain the 121 exemption, the property must not have been the subject of a 1031 exchange in the previous 5 years. Also,
at the time of the death of the taxpayer, the interested parties may be able to take the estate tax-free. This would depend on the
applicable inheritance laws at that time (currently at $2,000,000 for an individual).
Tenancy-in-Common ( Back to Top )
Q. What is a Tenancy-In-Common?
A tenancy-in-common is a form of ownership of real property whereby two or more individuals own an undivided interest in the
property, and upon an owner’s death, the interest passes to the owner’s heirs. Interests in tenancies-in-common are usually
divisible, and can be placed into a 1031 Exchange independently.
Who is a Certified Exchange Specialist? ( Back to Top )
Q. Why would someone want to do a 1031 Exchange?
To defer capital gains tax on the sale of commercial, business, or investment property.
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