What are the requirements for a successful 1031 Exchange?
I recently got an email from Leonard, the “1031 guy” at Asset Exchange Company. This reminded me that it’s probably time for a bit of a refresher on the whole concept of 1031 Exchanges.
First off, what is a 1031 Exchange? In accordance with IRC Section 1031, this lets an investor sell a property, reinvest the proceeds into a new property and defer all capital gain taxes. It’s important to know that you must strictly adhere to the guidelines within the tax code in order to successfully perform this type of exchange.
Here are the four basics for success:
1) Property qualifications. According to the Internal Revenue code, the properties involved in an exchange must be held for productive use in trade, business or for an investment, and they must be considered like-kind. Like-kind can sometimes be confusing for investors, since all real estate falls under this category except real estate outside the United States. Investors selling a rental home, for example, can exchange into a four-plex, while investors selling a warehouse can exchange into a percentage interest in an office building. An exception to this rule is dealer property, which does not qualify for an exchange. Intent is the most important factor for determining dealer property, according to the IRS.
2) Timeline. An exchange must be completed within 180 days, and this time frame begins upon close of escrow of the relinquished property. In turn, the replacement property or properties must be acquired on or before midnight of the 180th day. Additionally, the IRS mandates that all potential replacement property must be identified by midnight of the 45th day.
3) Identification rules. As stated above, all potential replacement property must be identified by the 45th day of the exchange. There are two rules here: first, the 3 Property Rule, which allows for identification of any three properties of any price in the U.S, and second, the 200 percent rule, which is an option for identifying more than three properties. However, the combined value of these identified properties must not exceed 200 percent of the relinquished property.
4) Tax deferral requirements. Two requirements must be met in order to defer 100 percent of the capital gains tax liability: first, all cash that was generated in the first property’s sale must be reinvested, and second, a property equal or greater in value to the relinquished property must be purchased. Partial exchanges are also possible in trade-down situations where the replacement property is of less value than the relinquished property.
Asset Exchange is holding a free 1031 Exchange webinar tomorrow at 1 p.m. Click here to register.
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