1031 Exchange
The second in a three-part series
By Jefferson Riddell, Esq
Although 1031 Exchange [1] has been in the internal revenue code since 1921, the scope of its use in recent years is unprecedented. Originally an “out west” phenomenon, the use of 1031 Exchange has spread rapidly east in recent years.
I assume everyone knows what 1031 Exchange does, i.e., don’t pay tax on the sale of real estate that has been an investment, rental or business property as long as you are willing to reinvest in replacement property, and follow the rules and regulations for completion of a successful 1031 Exchange. But following the rules is not easy unless you do it every day.
The basic rule is that you must arrange the exchange before you close the sale of the property for which you want tax deferral. By the way, 1031 Exchange is not a tax exemption, but only a deferral. But most people think it is sound economics to have the use of the tax money you would have paid, at least for awhile (free loan from Uncle Sam). There are also a couple of ways to permanently avoid the tax, but that is beyond the scope of this article.
But back to the rules. First you find a buyer for your property. You can sign a contract to sell your property even before you set up the exchange. But before the closing, you must retain a 1031 Exchange Qualified Intermediary (QI) company, sign an Exchange Agreement with the QI company and then, at closing, the QI company receives the proceeds of sale from the closing agent and escrows the proceeds until they are sent by the QI company to the replacement property closing agent to show as a buyer credit on the replacement property closing statement. After that, the QI company closes out the exchange and gives you an accounting of how the money came in and how it went out.
You can have more than one relinquished property and/or more than one replacement property, but the applicable deadlines run from the date of closing of the first relinquished property. The deadlines are 45 days to identify your replacement property or properties, and 180 days to close on your replacement property. The 180 days includes the 45 days, and you start the count with the day following the date of closing of the first relinquished property. The 180 day rule actually says “180 days or the due date of your tax return for the year of sale of the relinquished property” so for closings after October 15, it may be necessary to file for an extension of the April 15 filing deadline if you need the full 180 days to complete the exchange.
Identification is tricky. IRS says you can identify three different ways, but you must pick only one. The first rule is called the “three property rule” and says, by the 45th day if you have not already closing on the replacement property, you can identify up to three properties by street address (or some other unambiguous identification) without regard to their value. The second rule is called the “200 percent rule”. This one says that, by the end of the 45th day, you can identify any number of properties, but the total value of those properties cannot exceed 200% of the sale price of your relinquished property. There is a third rule called the “95% rule” but it is not used very often in real estate exchanges. If you give the QI company your identification list by the 45th day, but you are unable to actually purchase the property or properties you want as replacement properties, you will end up paying your capital gains tax because you cannot change the list after the 45th day.
Click HERE [2] to read Part 1
Jeff Riddell is a Sarasota, Florida attorney specializing in 1031 Exchanges. He holds a real estate broker’s license, has published numerous articles on real estate transactions and most recently authored a book on titled 21st Century Real Estate Investing. U.S. 1031 Exchange Services [1], 3400 S. Tamiami Trail, Sarasota, FL 34239. Telephone: (877) 455-2628. Website: www.us1031.com [3]
Copyright © 2011 REAL Magazine
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