Since 1921, the rules for qualifying and completing 1031 exchanges have gradually broadened and become less restrictive. Even so, there are dos, don’ts, and several gray areas of which taxpayers should be aware. As an experienced Qualified A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary , Accruit is accustomed to dealing with all types of complex exchanges and wants to make sure that the complexity of exchange does not deter property owners from considering one. Accruit can help you put the pieces together for a successful 1031 exchange.
For the taxable gain to be deferred, specific vital requirements must be satisfied:
- Properties must be exchanged, rather than sold and then purchased
- There must be no constructive or actual receipt of proceeds received by the taxpayer from the transfer of the relinquished property pursuant to the relinquished property contract
- Properties must be “ Refers to the "nature or character" of the property and not to its "grade or quality." That is, real property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other real property. Personal property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other personal property, provided the personal property is of "like kind" or "like class." Professional tax advice should be obtained when planning exchanges. Like-Kind ”
- Properties must be held for business or investment purposes
- The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange must be equal or up in value
- The exchange must follow time limit and identification requirements: A taxpayer must acquire or identify the target replacement property within 45 days after the transfer of the relinquished property. Properties received (purchased) within the 45-day designation period are deemed to be identified. The replacement property must be designated in a written document, unambiguously described, signed by the taxpayer, and received by the qualified intermediary on or before the 45th day. If the taxpayer identifies replacement property within the designated period, the exchange period end date may be extended up to 180 days from the transfer of the first relinquished property. This provides the taxpayer with additional time to complete the exchange. However, it might be necessary for the taxpayer to file a tax-filing extension to utilize the full 180 days.
In a typical forward exchange, the taxpayer will hire a 1031 exchange qualified intermediary (QI) to help transact their exchange. The QI will hold the proceeds from the sale of the relinquished property to use later to purchase the identified replacement properties. Once the relinquished property is sold, the taxpayer has 45 days to identify replacement properties and 135 days after that to finalize their exchange for a total of 180 days. The property requirements can be found in more detail in “ Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange Explained: Equal or up in Value”. Here’s an example to better explain the timing regulations.
“Mr. Clark wants to sell his farmland and exchange it for a less laborious property. Before he lists his property, Mr. Clark reaches out to the QI he would like to work with and begins the necessary documentation for his exchange, then listing his farm for sale. Mr. Clark can look for replacement properties while his farm is on the market, but his identification period officially begins the day his farmland sells.
During his 45-day identification period, Mr. Clark identifies a small commercial office building he would like to acquire. One of the critical conditions when identifying property is the specific description when relaying the information to your QI. It would not suffice if Mr. Clark were to contact his QI and describe the property he would like to acquire as “an office building near the business district.” Mr. Clark must unambiguously identify his property, with an address, as “100 Main St. Denver, CO.””
There are two rules to follow when describing specified property:
- Replacement property is identified only if it is unambiguously described in the written document or agreement
- Real property is generally unambiguously described if it is characterized by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building)
Keep in mind that once a property is identified within the 45-day period, the only way to end the exchange early is if there occurs a material and substantial contingency that relates to the exchange is provided for in writing is beyond the taxpayer’s control or any other disqualified person. Otherwise, the funds must remain in the exchange account for the entire 180-day exchange period. For example:
“Mr. Clark identifies the property he wants to acquire early on in the 45 days. Once he gives written and unambiguous notice, the funds received from the sale of his old property must remain with the QI until the identified property is purchased or 180 days whichever is earlier.”