What is a 1031 Exchange?

A 1031 exchange, also called a like-kind exchange, LKE, Starker Trust, or tax deferred exchange was first authorized in 1921 when Congress recognized the importance of encouraging reinvestment in business assets. Today, taxpayers use 1031 exchanges to increase cash flow by deferring taxes on gains realized through the sale of real estate, as long as they reinvest those gains in replacement property.

1031 exchange is one of the most popular tax strategies available when selling and buying real estate “held for productive use in a trade or business or for investment.” By structuring the sale and purchase of property as an exchange, the owner can potentially reduce the recognized tax gain to zero. By reducing the taxes owed to the government, more cash is available for the purchase of new property.

The Like-Kind Standard

In the case of real estate exchanges, the "like‐kind" standard is usually easy to satisfy. Generally, any type of real property interest is like‐kind to any other type of real property. The properties do not have to be of the same nature. For example, a single-family home held as rental property could be exchanged for a vacant parcel of land purchased as an investment. Learn more about the "like-kind" standard.

Eligibility for 1031 Exchanges

Section 1031 of the tax code allows property owners to defer taxes on the sale of their real estate held for business or investment purposes. All types of taxpayers qualify: individuals, partnerships, limited liability companies, S corporations, C corporations and trusts (however, the same taxpayer that sells the relinquished property must purchase the replacement property). As long as the requirements for a tax‐deferred exchange are satisfied, and the sale proceeds are reinvested in like‐kind property, the tax gain can be deferred.

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1031 Exchange Requirements

In order for the taxable gain to be deferred, certain key requirements must be satisfied:

Properties Must Be Exchanged

By itself, a sale followed by a purchase does not qualify as a 1031 Exchange. Instead, the transaction must be treated as an exchange for tax purposes. To convert a sale followed by a purchase into an exchange, a property owner will employ the services of a qualified intermediary (QI) who acts as a middleman to tie the sale to a buyer and the purchase from a seller as a verified exchange. It’s very important for the QI to be contacted prior to the closing of the sale and/or purchase transaction.

Held for Business or Investment Purposes

Both the relinquished property and the replacement property must be held for business or investment purposes. A sale of business property is not required to be replaced with other business property; it can be replaced with investment property or vice versa.

No Constructive or Actual Receipt of Exchange Funds

It is a violation if the taxpayer or an agent for the taxpayer receives exchange funds or the taxpayer is directly or indirectly able to control the exchange funds during the exchange period.

1031 Exchange Time Limit & Identification Requirement

A taxpayer is required to acquire or identify the target replacement property within 45 days after the transfer of the relinquished property. Properties acquired within the 45-day designation period are deemed to be identified. 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 designation 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 additional time to complete the exchange, however, it might be necessary for the taxpayer to file a tax-filing extension in order to utilize the full 180 days.

Properties Must Be “Like‐Kind”

One of the advantages to exchanging real estate is that almost all real property is considered to be of like‐kind to all other real property.

Exchange Equal or Up in Value

To potentially defer all of the tax gain, a property owner must first reinvest all of the equity in the relinquished property into the replacement property. Second, the purchase price of the property acquired must equal or exceed the sale price of the relinquished property.  Typically, this requires debt on the new property to equal or exceed the debt that is paid off on the relinquished property.

Tax deferred exchanges are authorized by Section 1031 of the Internal Revenue Code (IRC). The comprehensive set of tax laws created by the Internal Revenue Service (IRS). This code was enacted as Title 26 of the United States Code by Congress, and is sometimes also referred to as the Internal Revenue Title. The code is organized according to topic, and covers all relevant rules pertaining to income, gift, estate, sales, payroll and excise taxes. Internal Revenue Code Internal Revenue Code and the requirements of the code section and the corresponding regulations must be carefully met.  When the like-kind exchange is done properly, the tax on the transaction is deferred.

Use of a Qualified Intermediary

An unrelated third party or “qualified intermediary” (QI) may be used to facilitate the 1031 exchange transaction. A taxpayer cannot utilize their Realtor®, lawyer, accountant or a related party as a QI. Additionally, several states require that QIs be compliant with regulatory requirements regarding insurance, bonding, and the manner in which exchange funds are held, state licensing, etc.

How Do Simple Forward 1031 Exchanges Work?

a windmill and sunset
Individual or multiple properties may be exchanged as part of a 1031 tax deferred exchange or like-kind exchange transaction. An exchange agreement between the taxpayer and the qualified intermediary (QI) must be set up prior to any sales transaction. The first part of the exchange occurs when the taxpayer assigns their rights to sell the relinquished property to the QI. Upon the sale of the relinquished property, the proceeds are held by the qualified Intermediary in an exchange account as the taxpayer cannot receive any proceeds from the sale of the relinquished property either actually or constructively. The next portion of the exchange involves the identification and purchase of 1031 replacement property. Specific requirements defined in section 1031 include a 45-day identification period and a 180-day period in which to close on a replacement property, which run concurrently beginning on the date the relinquished property is sold.

Once a replacement property is selected, the rights to acquire that property are assigned to the QI. The funds held in a taxpayer’s exchange account would be sent by the QI directly to the closing for the purchase of the replacement property.

Please download our step-by-step 1031 forward exchange whitepaper for detailed information about how to complete a 1031 exchange.

Step 1

Contact Accruit to start an exchange and obtain a forward exchange document package:

  • Call: 800-237-1031
  • E-mail: info@accruit.com

Complete all blanks in the Exchange Agreement, the Qualified An escrow agreement provides for the placement of money or other assets in the control of an independent third party in order to protect the parties involved in a transaction. The funds or assets are held by the escrow agent until it receives the appropriate instructions or until predetermined contractual obligations contained in the escrow agreement have been fulfilled. Escrow Agreement and the W-9 and have them executed by the taxpayer and returned with a driver’s license or entity confirmation of good standing.

Step 2

Complete all blanks in the Assignment of Relinquished Property Contract form and have it executed by the taxpayer. The Agreement between the Exchanger and the Qualified Intermediary, establishing the Exchanger’s intent to complete a Like-Kind Exchange and detailing each party’s roles and responsibilities. The Exchange Agreement must detail the exchange in accordance with the deferred exchange regulations. Exchange Agreement together with a copy of the Assignment of Relinquished Property Contract and a copy of the subject contract should be delivered to Accruit.

Step 3

On or before closing, notice of the fact of the assignment must be made in writing to the buyer and all other parties to the contract, including co-sellers, if any. This means that if there are multiple sellers in addition to the taxpayer, they must also receive written notice. There is no requirement in the Regulations for any parties to receipt for the notice of assignment however it might be advantageous to request such receipt in the unlikely event of an IRS audit, as a definitive way to prove notice was given. The notice may be done with use of the available form or by a separate letter in a format, which can be provided by our office upon request.

Step 4

At closing, the settlement agent should be directed by the taxpayer to have the taxpayer’s net proceeds check made payable to Accruit, under the taxpayer’s account number. It is preferred however to have the net proceeds sent via wire transfer using wire transfer instructions provided in the forward exchange document package. Despite the fact of the exchange, the taxpayer should expect to receive a 1099 from the settlement agent, the potential tax effect of sending the 1099 to the IRS will be negated later via a filing of an IRS Form 8842, confirming a successful exchange. If Accruit’s fee has not sooner been paid, the closing statement should provide for payment of such fee. If a separate check is not received, Accruit will debit the exchange funds upon receipt of them for the amount of the fee.

Step 5

Within 45 days from the date of transfer of the relinquished property or the old asset, written notice of the identification, or designation, of target property(ies) should be given to Accruit, or to any other non-disqualified person involved in the exchange. For more information on identifying replacement property in a 1031 exchange please read “Rules for Identification and Receipt of Replacement Property in an IRC §1031 Tax A 1031 exchange conducted under the safe harbor 1991 Treasury Regulations wherein the replacement property is received up to 180 days after the disposition of the relinquished property. Typically what people mean when referring to a 1031 exchange, Starker exchange, like-kind exchange, delayed exchange, etc. Deferred Exchange .” Keep in mind, it is relatively simple if the taxpayer identifies three properties or less. If more than three properties are identified and the sum of the market value of all such properties is more than 200% of the market value of the property sold, the taxpayer must be prepared to close on at least 95% in value, of the properties identified. Also, remember, once property is identified within the 45 day period, the only way to terminate the account early is if there occurs a material and substantial contingency that relates to the exchange, is provided for in writing is beyond the control of the taxpayer or any other disqualified person. Otherwise, the funds have to remain in the exchange account for the full 180 day exchange period. If the expiration of the 45 day exchange period crosses over into a second tax year without any identification or should the 180 day exchange period cross into a second tax year without any acquisition, the taxpayer can choose to report the gain (i) in the year the sale took place or (ii) the year in which the taxpayer received the distribution from the exchange account.

Step 7

At any time, on or after property is designated, and assigned to Accruit, the taxpayer, or his or her attorney, may submit a written request that earnest money be paid out pursuant to the provisions of the contract. A form is available and included in the package of exchange documents to make disbursement requests.

Step 8

On or before closing, notice of the fact of the assignment must be made in writing to the seller and all other parties to the contract, including co-buyers, if any. This means that if there are multiple buyers in addition to the taxpayer, they must also receive written notice. There is no requirement for any parties to receipt for the notice of assignment however it might be helpful to obtain one for your file in the unlikely event of an IRS audit. The notice may be done with use of the available form or by separate letter.

Step 9

At any time prior to closing on the purchase of the replacement property, the taxpayer, or his or her attorney, may submit a signed request that available funds be wired (or a check prepared) to the settlement agent in connection with the purchase.

Step 10

At the beginning of the following tax year, the depository bank where the exchange funds were held in an escrow account will send the taxpayer a 1099 in the amount of interest that accrued on the exchange deposit. This should be reported as income, and the taxpayer should report the exchange transaction on IRS form 8824, together with any other applicable forms.

Forward Exchanges Download

What is a Reverse Exchange?

When a taxpayer needs to purchase their replacement property prior to the closing of their relinquished property a reverse exchange may be an alternative to allow for a 1031 tax deferred exchange to occur.

The most common reverse exchange structure involves the exchange accommodation titleholder (EAT) taking title to or “parking” the property which the taxpayer intends to use as a replacement property in a 1031 exchange.  This type of exchange may be referred to as parking the replacement property or as an exchange last reverse 1031 exchange.

The IRS provides a safe harbor for a reverse 1031 exchange provided that the certain conditions are met.  The taxpayer must enter into a " This is a term that the IRS coined in the “reverse exchange” Rev. Proc. 2000-39 pertaining to the overarching agreement which must be put in place between the Exchange Accommodation Titleholder and the taxpayer. The Rev. Proc. contains certain provisions which are mandatory to be in the agreement in order for these parking arrangements to be in the safe harbor set forth in the Rev. Proc. This applies to reverse exchanges of relinquished or replacement property as well as build-to-suit and property improvement exchanges. Qualified Exchange Accommodation Agreement " (QEAA) with an EAT that states that the taxpayer intends to meet the requirements of Section 1031 and Revenue Procedure 2000-37.

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What are the Requirements of a Reverse Exchange?

Similar to a forward 1031 exchange, there are certain timing and documentation requirements for the reverse exchange to be valid. These include:

  1. The QEAA needs to be entered into within five days of when the EAT purchases the replacement property.
  2. Within 45 days of the purchase of the parked property, the taxpayer must complete an identification form indicating the relinquished property that will be sold in conjunction with the exchange.
  3. The parked property must be transferred to the taxpayer on or before the 180th day from the date of acquisition by the EAT. This generally occurs immediately after the taxpayer’s relinquished property is sold. The parked property becomes the taxpayer’s 1031 replacement property.

In reverse exchanges, the IRS allows for the taxpayer to:

  • advance funds to the EAT to acquire the parked property
  • guarantee the debt used to acquire the parked property
  • manage the replacement property during the parking period
  • supervise any construction or improvements on the parked property

There are different ways to structure and administer reverse exchanges within the safe harbor, including reverse exchanges where the relinquished property, rather than the replacement property, is the property that is held by the EAT (an exchange first transaction).

Step 1

The taxpayer enters into a contract to purchase the replacement property, and the contract has no restriction against assigning the contract to a third party. In the unlikely event that it is so restricted, the contract should be negotiated to allow the contract to be assigned to the reverse exchange accommodator, AEAS or a special purpose entity (SPE), typically an LLC, owned by AEAS to hold title to the property. Under IRS vernacular, the SPE is known as a Qualified Also referred to as an "EAT", is typically a special purpose, limited-liability company that is used to own the legal title to property that is being parked as part of a reverse exchange. An exchange accommodation titleholder may not be a disqualified person. Exchange Accommodation Titleholder (EAT).

Step 2

The taxpayer or their advisor contacts Accruit to start an exchange and obtain a reverse exchange document package:

  • Call: 800-237-1031
  • E-mail: info@accruit.com

The taxpayer and AEAS, enter into a This is a term that the IRS coined in the “reverse exchange” Rev. Proc. 2000-39 pertaining to the overarching agreement which must be put in place between the Exchange Accommodation Titleholder and the taxpayer. The Rev. Proc. contains certain provisions which are mandatory to be in the agreement in order for these parking arrangements to be in the safe harbor set forth in the Rev. Proc. This applies to reverse exchanges of relinquished or replacement property as well as build-to-suit and property improvement exchanges. Qualified Exchange Accommodation Agreement (QEAA) for replacement property whereby the SPE, as the EAT, will take title on the date of closing to the replacement property. The SPE is set up with Accruit Exchange Accommodation Services, LLC as its sole member.

Step 3

The taxpayer assigns the replacement property purchase contract to the EAT.

Step 4

Unless the taxpayer is providing 100% of the necessary funds, a taxpayer selected lending bank loans the funds required for the purchase to the EAT to enable it to acquire the replacement property. The EAT signs any applicable loan documents as the borrower, however, the taxpayer signs as the guarantor of any such loan. In the event the bank does not make a 100% loan-to-value loan, the taxpayer makes a second loan for the balance needed, which should include any earnest money that may have been previously advanced. The documents required for any taxpayer loan are furnished by Accruit and typically include a Non-Recourse Promissory Note and a Pledge Agreement of Membership A charge paid by a borrower to a lender for the opportunity to borrow funds via a loan or the funds earned by an account owner/beneficiary on the amount held on deposit. Interest to secure the loan.

Step 5

The taxpayer and the EAT enter into a contract for the sale of the replacement property from the SPE to the taxpayer as well as a triple net In the context of reverse exchange administration a Master Lease between the Exchange Accommodation Titleholder as Lessor and the taxpayer as Lessee, is often used in order for taxpayer to be able to sublease the property to the actual property tenants. This removes the need for the Exchange Accommodation Titleholder from having any interaction with the property tenants. If also puts responsibility on the taxpayer to pay for utilities, taxes and insurance. Master Lease , which allows the taxpayer to oversee the day-to-day management of the property while it is held by the EAT. The lease provides that, in lieu of rent, the taxpayer will pay all debt service to the lender and/or the taxpayer, assuming a secondary loan from the taxpayer. Accruit may request that the taxpayer execute an Environmental Indemnity Agreement.

Step 6

Funds are sent directly to the closing by the lender and/or the taxpayer. The closing takes place and the SPE takes title to the property. Evidence of liability insurance must be furnished to Accruit showing the SPE as the insured party, while the lender and the taxpayer may appear as additional insureds.

Step 7

Within six months (180 days) of the replacement property closing, the taxpayer enters into a contract for the sale of the relinquished property and enters into a standard Tax A 1031 exchange conducted under the safe harbor 1991 Treasury Regulations wherein the replacement property is received up to 180 days after the disposition of the relinquished property. Typically what people mean when referring to a 1031 exchange, Starker exchange, like-kind exchange, delayed exchange, etc. Deferred Exchange Agreement with Accruit, who serves as the QI. The taxpayer assigns its rights (but not its obligations) under the contract for the sale of the relinquished property to the QI and gives to the buyer(s) written notice of this assignment on or before the closing. The closing must take place within the 180-day period and the net proceeds of the sale are paid to the QI.

Step 8

The taxpayer assigns its rights under the contract for the purchase of the replacement property (which is now being acquired from the EAT) to the QI and gives written notice of this assignment to the EAT, on or before the closing.

Step 9

The taxpayer directs the QI to disburse the exchange proceeds to the EAT as part, or all, of the purchase price. The EAT receives the funds and immediately wires those funds to the lending bank and/or to the taxpayer to pay down all or part of the debt.

Step 10

The taxpayer takes ownership of the replacement property via an assignment of the membership interest in the EAT which transfers the LLC, and the property it holds, from the member (AEAS) to the taxpayer. Alternatively, a deed may be issued to the taxpayer by the EAT and the LLC may be dissolved. The taxpayer takes the membership interest or the deed relating to the replacement property subject to the balance of any debt.

Non-Safe Harbor Reverse Exchanges

For reverse exchanges that take longer than 180 days, an exchange may still be successful and “long term” parking arrangements may be utilized. For additional information about non-safe harbor parking exchanges please refer to: Non-Safe Harbor Parking Arrangements for 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 s
Accruit provides all types of complex parking transactions. Accruit Exchange Accommodation Services, LLC offers nationwide exchange accommodation titleholder services. For more information please contact us.

Parking Exchanges Download

What are Build-to-Suit, Construction or Improvement Exchanges?

Taxpayers sometimes need to acquire property on which they desire to construct improvements or complete renovations that they wish to include as part of their exchange replacement property. Improvements on land a taxpayer has already acquired will not count as replacement property in a 1031 tax deferred exchange. By utilizing a build-to-suit, improvement or construction exchange, it would be possible for a taxpayer to receive property that is improved to the taxpayer's specifications in a tax deferred exchange. When an exchange involves replacement (new) property that is land to be constructed upon or a structure requiring improvements, a build-to-suit or a property improvement exchange will allow for the inclusion of the improvement costs in the exchange value of the replacement property. If the relinquished property is sold prior to the acquisition and improvement of the replacement property, the exchange is a FORWARD build-to-suit or improvement exchange. When the acquisition and improvement of the replacement property precedes the sale of the relinquished property, it is a REVERSE build-to-suit or improvement exchange.

Step 1

The taxpayer or their advisor will contact an exchange facilitator such as Accruit to start a forward build-to-suit or property improvement exchange:

  • Call: 800-237-1031
  • E-mail: info@accruit.com

Step 2

The taxpayer enters into a contract with their buyer for the sale of the relinquished (old) property. They also enter into a standard tax deferred exchange agreement with the QI. The taxpayer assigns their rights (but not their obligations) under the contract for the sale of the relinquished property to the QI and gives to the buyer written notice of this assignment on or before the closing. The net proceeds of the sale are paid directly into an exchange account with the QI.

Step 3

The taxpayer enters into a contract to purchase the replacement (new) property. This contract must allow for a third party, the EAT in this case, to acquire the property on behalf of the taxpayer. This third party is customarily a special purpose entity (SPE), typically an LLC, owned by the EAT and created strictly for the purpose of holding title to a specific property. The LLC is also referred to as Titleholder.

The taxpayer and the QI enter into a This is a term that the IRS coined in the “reverse exchange” Rev. Proc. 2000-39 pertaining to the overarching agreement which must be put in place between the Exchange Accommodation Titleholder and the taxpayer. The Rev. Proc. contains certain provisions which are mandatory to be in the agreement in order for these parking arrangements to be in the safe harbor set forth in the Rev. Proc. This applies to reverse exchanges of relinquished or replacement property as well as build-to-suit and property improvement exchanges. Qualified Exchange Accommodation Agreement (QEAA) for the replacement property in which the Titleholder will take title on the date of closing to the replacement property. The taxpayer assigns the replacement property purchase contract to the Titleholder so that the EAT may stand in the place of the taxpayer.

Step 4

The taxpayer and the EAT enter into a contract for the sale of the replacement property to the taxpayer, to take place after the property is improved.

Step 5

The taxpayer can direct funds from the sale of the relinquished property from the exchange account to the EAT. This is considered a partial payment from the taxpayer to the EAT under the Build-to-Suit or Property Improvement contract. The EAT, in turn will use these funds to purchase the replacement property.

Step 6

Any improvements are begun following a written agreement with the contractor or other service provider. This agreement is executed by the Titleholder or assigned to the Titleholder by the taxpayer if it has already been executed. The taxpayer directs funds from the exchange account to the Titleholder progressively, as the work is done. Whenever a payment is to be made by the Titleholder, the taxpayer tenders a draw approval form to the Titleholder confirming that they are satisfied with the applicable work and that the Titleholder may make payment.

Step 7

The taxpayer assigns its rights under the contract for the purchase of the replacement property, now being acquired from the EAT, to the QI and gives written notice of this assignment to the EAT, on or before the closing.

Step 8

The taxpayer takes ownership of the replacement property via an assignment of the membership interest in the EAT, which transfers the membership interest in the titleholder LLC and the property it holds, from the EAT to the taxpayer. Alternatively, a deed may be issued to the taxpayer by the Titleholder and the LLC may be dissolved. The taxpayer takes the membership interest or the deed for the replacement property subject to the balance of any debt.

The preceding steps outline a forward build-tosuit or property improvement exchange, in which the taxpayer sells the relinquished property prior
to the acquisition of the replacement property. If the taxpayer wishes to acquire and begin the improvements on the new property before the sale of the old property, a reverse build-to-suit or property improvement exchange is necessary.

In the case of a reverse type exchange, funding to cover the purchase price and cost of improvements must be provided to the EAT from a bank and/or taxpayer loan. In this instance, the Titleholder will sign loan documents as the borrower, and the taxpayer signs as the guarantor of the loan. Any earnest money having been put down is considered part of the funds lent from the taxpayer to the Titleholder. These loans get paid back at the conclusion of the transaction when the exchange funds are used by the taxpayer to acquire the property from the EAT.

Example of a Simple Forward Improvement Exchange

In a forward improvement or construction exchange, for example, 1031 proceeds from the sale of the relinquished property are received and held by the qualified intermediary (QI) under a tax deferred exchange agreement and the related assignment agreement. 

Under a separate qualified exchange accommodation agreement (QEAA) and related documents entered into between the taxpayer and the exchange accommodation titleholder (EAT), the 1031 proceeds are then used by the EAT to purchase the property requiring the improvements.

Within the 180-day period after the sale of the relinquished property, while the replacement property is parked with the EAT, improvements may be constructed on the property. Exchange proceeds may be used to fund the improvements through draw requests submitted by the taxpayer to the QI and the EAT.  If there are not sufficient exchange funds for the purchase and the desired improvements, the taxpayer may provide additional funds to the EAT or may secure a loan to provide the necessary funds.

In a safe-harbor transaction, transfer of the improved replacement property is made from the EAT to the taxpayer within 180 days after the relinquished property sale.

Build to Suit Property Improvement Exchange Download

Frequently Asked Questions

The IRS has extended 45-day identification period and the 180-day exchange period for taxpayers impacted by the pandemic. For more details, see Deadline Extension for 1031 Exchanges due to COVID-19.

 

One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to effect a 1031 exchange and others simply wish to cash out. While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share. The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.” Read more about drop and swaps in our post, 1031 Drop and Swap out of a Partnership or LLC

The difference between 1031 and 1033 exchanges: section 1033 is tax deferral specific to the loss of property by a taxpayer and is therefore is referred to as an involutary conversion. Section 1031 is the voluntary replacement of either real or personal property in an exchange of business or investment assets. Finally, while Section 1031 generally requires the use of a qualified intermediary, Section 1033 does not.

The 45 day rule refers to the period a taxpayer has to identify replacement property from the date of sale. According to exchange regulations: “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.” The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.

For more information, see our blog post: What are the Rules for Identification and Receipt of Replacement Property in an IRC 1031 Tax Deferred Exchange?

Allowable closing expenses for 1031 exchange purposes are: Real estate broker’s commissions, finder or referral fees Owner’s title insurance premiums Closing agent fees (title, escrow or attorney closing fees) Attorney or tax advisor fees related to the sale or the purchase of the property Recording and filing fees, documentary or transfer tax fees Closing expenses which result in a taxable event are: Pro-rated rents Security deposits Utility payments Property taxes and insurance Associations dues Repairs and maintenance costs Insurance premiums Loan acquisition fees: points, appraisals, mortgage insurance, lenders title insurance, inspections and other loan processing fees and costs For more information about allowable closing expenses, see What are Valid 1031 Exchange Selling Expenses?

(“Exchangor" or "Exchanger") Individual or entity desiring an exchange. Taxpayer s sometimes wish to generate some cash on or around the time of selling relinquished property as the first leg of an exchange. Any sums paid to the taxpayer at closing are subject to taxation. As an alternative, a taxpayer may wish to refinance the relinquished property before the exchange or refinance the replacement property after the exchange. However, in the absence of mitigating factors, refinancing the relinquished property is generally discouraged. See Cash Out Refinance Before or After a 1031 Exchange? for more information

In situations where the relinquished property sells for a greater value than the replacement property, it is possible for construction or improvement costs to reduce the taxable amount. Read Can Property Improvement Costs Be Part of a 1031 Tax Deferred Exchange? for an in-depth explanation of build-to-suit and property improvement exchanges.

The IRS Code does not allow members/partners to do his or her own exchange, only the entity can do so. Given enough preplanning, there is a technique referred to as a “drop & swap” whereby certain members/partners can drop their interest from the entity and enter into the exchange individually and not at a member/partner.

No, in order to fully shelter the gain, the sale price of the relinquished property, net of closing costs must be reinvested.  Another way to look at this is that the net amount going into the exchange account must be reinvested and there has to be equal or greater mortgage debt on the new property compared to what was paid off upon closing of the old property.

Under the regulations there are quite a few options to deal with holding the money from the sale.  Some do not require putting the money with the QI although that is generally the easiest and most convenient.  The real reason a taxpayer has to use a QI is, through the paperwork provided, use of a QI converts the transaction of the sale of a property and the later purchase of a new property to an exchange of the one for the other.

No, there is no requirement under the regulations that the counterparty needs to sign receipt of the notice of assignment.  Rather the only requirement is that the other party needs to receive the notice of the assignment.  Receipt for it may be a common courtesy but it does not harm the exchange if the party prefers not to sign for that notice.

 

No, an exchange is a like kind exchange of real estate for other real estate.  Incidental costs such as paying loan related fees do not constitute the direct payment for like kind real estate.

To pay such fees out of an exchange account, the fee needs to meet two pronged criteria.  First, the fee has to related only to legal services pertaining to the sale and/or purchase.  The second one is that the type of payment must be one that is typically found on a closing statement in the locale where the property transaction takes place.

Yes, the Regulations require that all parties to the contract have to receive notice of the assignment by the taxpayer of his/her interest.  So should there be other parties selling or buying with the taxpayer, those parties must get the notice as well as the party on the opposite side.

No, the Regulations provide that any party to the exchange can be the necessary recipient of the notice.  So, for example if the contract with the seller of the new property contains a reference in the contract stating that this is the replacement property for the buyer’s exchange, that would be sufficient.

No, this is a misconception.  The two year curative provision only applies if the related parties are exchanging directly with one another.  This is seldom the case.  In a situation where the taxpayer sells the relinquished property to a third party and acquires and holds replacement property for an excess of two years from the related party, that is not sufficient to meet the rule.

No, the purpose of adding the related party rules to the Tax Code was to prevent taxpayers from manipulating the tax result by buying replacement property from a related party such as a subsidiary company.  That so called tax abuse is not applicable when a party is selling the relinquished property to a related party.

Yes, the related party rules to not necessarily include all relatives.  Rather they disallow persons that are descendants or one another.  Lineal descendants such as Parent, child, grandparents, siblings are considered related for this purpose, not so for in laws, aunts, uncles, cousins, etc.

No, effective with the current changes to the Tax Code made beginning with the year 2018, only real estate can be the subject of an exchange.  As a result, personal property such as a business or franchise cannot be the subject of exchanges.

While there is nothing in the Regulations on this question, for technical reasons it is considered bad practice to refinance in anticipation of entering into an exchange.  By doing so, it changes the amounts on cash and debt that would need to be applied to the replacement property acquisition and it is tantamount to “gaming the system”.  Refinancing after an exchange to pull some equity out does not have these issues and is considered proper.

Yes, that does not cause any issues since the exchange rules do not come into play until the time the relinquished property is transferred.  At that time neither the taxpayer nor his/her agent should be holding onto exchange funds.

Yes, but there are some challenges.  If a taxpayer is selling on an installment basis, to the extent that the majority of the purchase price is payable beyond the 180-day exchange period, the taxpayer can only get deferral if he/she advances the amount into the replacement property even though it may not be received for a period of years.  A buyer can but under an installment contract and the balance that is carried by the seller is treated like any other debt, such as a new loan by a bank lender.

Yes, same answer as above. The seller would have to advance the sum being financed into the replacement property.  Later receipt of that principal sum from the buyer would be tax deferred.  A charge paid by a borrower to a lender for the opportunity to borrow funds via a loan or the funds earned by an account owner/beneficiary on the amount held on deposit. Interest paid during that period would be taxable.

As a rule of thumb, it is generally easier to park the replacement property.  However, when the taxpayer has financing set up for the replacement property that the lender will not allow to be in the name of the Accommodator, this cannot be done.  There may be other reasons as well such as known environmental issues on the replacement property.

Yes, many people think if they are doing a reverse exchange, that is an alterative in lieu of the reverse exchange.  That is not correct.  The only thing a reverse exchange does is to allow the taxpayer to effectively control the replacement property when the corresponding relinquished property cannot be sold first.  A forward exchange is still necessary to actually exchange the old property for the new property. 

The default is that the payment of the tax is treated as an installment and payable in the year in which the funds were able to be paid out. Should a particular taxpayer wish to pay it in the first year to take advantage of tax losses in that year or for other reasons that can be done by a special election.

No, this is a common problem. Since for exchange purposes a taxpayer has to roll over all the net cash, the amount of the loan should be for the remainder of the purchase price.

The IRS issued a ruling years ago that said for purpose of the Accommodator’s role in holing and transferring reverse exchange property, it could be considered the agent of the taxpayer and as a result extra transfer taxes did not need to be paid. There are a few states that still require payment regardless of the IRS ruling.

The IRS rules allow the taxpayer to lend the necessary funds to the Accommodator, but just like a bank lending funds, those funds are typically provided directly to the settlement agent and do not need to come to and through the Accommodator.

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