The Section 1031 exchange is widely considered to be the last great wealth building tool available to investors. For investment or income property owners it remains an unsurpassed tool which drives equity growth, uniquely defers capital gain taxes and depreciation recapture, and overall builds value.Learn More
Every exchange deserves to be planned beforehand. With the limited time constraints and the logistical difficulties associated with closing multiple properties, spending some time laying out the objectives will allow an Exchanger to minimize obstacles and create suitable contingencies.
The most difficult part of any 1031 exchange is locating and identifying candidate or target replacement properties within the brief 45 day identification period. The Exchanger is also required to identify using the three property rule, the 200 percent rule, or the 95 percent exception.
The othe time related rule is that all the replacement properties must be acquired and closed within 180 days or whenever your tax return is due. This means if it is late in the year, you may need to file an extension of your tax return to access all 180 days.
The IRS views the taxpayer's use of Section 1031 as a method for moving the cost basis from one qualifying property to another. Therefore your exchange must be reported to the IRS on Form 8824 with your tax return for the year in which the exchange was started.
Prior to Congress modifying the Internal Revenue Code and formally approving the concept of delayed exchanging, virtually all exchanges were of the simultaneous type. To qualify as a simultaneous exchange, both the relinquished property and the replacement property must close and record on the same day.
Generally, when one discusses exchanges, the type of exchange referred to is the delayed, deferred or Starker exchange. This term comes from the name of the Exchanger who was first challenged for a delayed exchange by the IRS. From this tax court conflict came the code change in 1984 that formally recognized the delayed exchange for the first time. This is now the most common type of exchange.
In a delayed exchange, the Relinquished Property is sold at Time 1, and after a delay of up to 180 days, the Replacement Property is acquired at Time 2.
The reverse exchange represents an exchange in which the Exchanger locates a Replacement Property and wants to acquire it before the actual closing of the Relinquished Property. Since the Exchanger cannot purchase the Replacement and later exchange into property that he already owns, he must find a method to acquire the Replacement Property and still maintain the integrity of the exchange.
The most common reverse exchange approach is for the Exchanger to arrange the acquisition of the Replacement Property by adding enough cash (or arranging suitable financing) to buy the new property. The title for the new property is then held by an Exchange Accommodation Titleholder (an LLC created by the Qualified Intermediary). The EAT holds title to the Replacement property until such a time within the 180 day exchange period that the Relinquished Property is sold. At that time either the Replacement Property is deeded to the Exchanger by the EAT, or the EAT itself is transferred to the Exchanger.
In some cases, the replacement property requires new construction or significant improvements to be completed in order to make it viable for the specific purpose the Exchanger has intended for the property. Such construction or improvements can be accomplished as part of the exchange process, with payments to contractors and other suppliers being made by the Qualified Intermediary or Facilitator out of funds held in a trust account. Therefore, if the replacement property is of lesser value than the relinquished property at the time of the original transaction, the improvement or construction costs can bring the value of the replacement property up to an exchange level or value which would allow the transaction to remain completely tax deferred. Most improvement or construction exchanges utilize an Exchange Accommodation Titleholder to hold the title to the property while the improvements are completed. This avoids a situation where the Exchanger is exchanging into property he already owns.
This comprehensive guide to 1031 exchanging will cover everything you need to know to be an informed Exchanger.
If you just have a question or two check out this FAQ and you'll probably find the answer to your inquiry.
There are a handful of keys to 1031 exchanging which experienced Exchangers always heed. See them for yourself.
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