1031 Exchange Rules – How To Do a 1031 Exchange
The information presented on this page is based on (1) an article called “How To Do a 1031 Exchange: Rules & Definitions for Investors” written by Ben Erik Smith and published by Real Wealth Network, and (2) an article called “1031 Exchange Rules and Requirements” published by Atlas 1031 Exchange LLC.
According to Kathy Fettke, Co-CEO and Co-Founder of Real Wealth Network, “A 1031 Exchange is a powerful tax-deferment strategy used by some of the most financially successful investors.” She says that this is especially true today, because “prices in many U.S. cities have surpassed the “bubble levels” of a decade year ago. Because of this, many real estate investors think that 2016 is the optimal time to exchange properties in expensive markets for cash-flow properties across the country by following the 1031 exchange rules.” (1)
“The primary 1031 exchange rules and requirements include: 1) same taxpayer: the taxpayer who sells is the taxpayer who buys, 2) property identification within 45 calendar days post closing of the first property, 3) purchase of the replacement property within 180 calendar days, 4) trading up: the price of the replacement property is equal to or greater than the old or relinquished property, 5) hold time supports the intent to hold for investment, and 6) related party transaction regulations.” (2)
1031 Exchange Rules 1: Same Taxpayer
1031 Exchange Rules: “The tax return and name appearing on the title of the property that sells must be the tax return and titleholder that buys. A single member limited liability company (smllc) is considered a pass through to the member, consequently, the smllc may sell and the member may purchase in their individual name.” (2)
1031 Exchange Rules 2: Property Identification
1031 Exchange Rules: “Post closing of the first property, the Exchangor has 45 calendar days to identify to either the accommodator or the closing entity the addresses of the potential replacement properties. In a reverse exchange where either the replacement or relinquished property is parked, the Exchangor has 45 days to submit a final list of properties for sale or purchase.
• Three property rule - can identify any three properties regardless of value.
• Two hundred percent rule - can identify four or more properties as long as the value does not exceed 200 percent percent of the property sold.
• 95-percent exception rule - if the value exceeds 200 percent, then 95 percent of what is identified must be purchased.” (2)
1031 Exchange Rules 3: Replacement
1031 Exchange Rules: “Within 180 calendar days following the closing of the first property or
extension of the Exchangor's tax return, the property must be purchased.” (2)
1031 Exchange Rules 4: Trading Up
1031 Exchange Rules: “The net market value and equity of the property sold must be less than or equal to the replacement property to defer 100 percent of the tax. Otherwise, the Exchangor needs to pay tax on the difference. Debt and equity in the replacement property must be equal to or greater than the debt and equity in the relinquished property. Additional equity in the replacement property offsets debt. Additional debt does not offset equity.” (2)
1031 Exchange Rules 5: Hold Time
1031 Exchange Rules: “Though there is no hold time in the 1031 code, the Internal Revenue Service looks to determine whether the property was acquired immediately before the exchange. Was it purchased to fix and flip or held for productive use or investment? Time is one of many factors that supports the intent to hold for investment. The shorter the time, the more substantial the facts should be to support the intent. Additional supportive facts are whether the property is itemized on Schedule E or Schedule A. Investment properties are listed on Schedule E. Was the property rented? Does the level of personal use exceed 14 overnights per year? If so, the character may resemble a second home.” (2)
1031 Exchange Rules 6: Related Party
1031 Exchange Rules: “The term "related person" or "related party" means any person or party, including entities, that has a relationship to the taxpayer described in Section 267(b) or Section 707(b)(1) of the Internal Revenue Code ("IRC").” (2)
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How To Do a 1031 Exchange Right Now, According To Real Wealth Network:
“To do a 1031 exchange effectively, you must exchange one property for another property of similar value. In the process you avoid capital gains, at least for a while.
An investor will eventually cash out and pay taxes, but in the meantime, an investor can trade properties without incurring a sudden tax obligation. It’s an important tool for real estate investors that has become a bulls-eye for tax reform evangelists.
However, the 1031 Exchange Rules require that both the purchase price and the new loan amount be the same or higher on the replacement property.”
That means that if an investor were selling a $750,000 property in Dallas that had a $500,000 loan, they would have to buy $750,000 or more of replacement property with $500,000 or more leverage. (1)
If you are interested here are Property 1031 Exchange Rules & Guidelines To Remember
1031 Exchange Rules Reminder: “To qualify as a 1031 exchange, the property being sold and the property being acquired must be “like-kind.”” This is a very broad term, meaning that “both of the properties must be “the same nature or character, even if they differ in grade or quality. In other words, you can’t exchange farming equipment for an apartment building, because they’re not the same asset. In terms of real estate, you can exchange almost any type of property, as long as it’s not personal property.” (1)
1031 Exchange Rules Reminder: “A 1031 exchange is only applicable for Investment or business property, not personal property. In other words, you can’t swap one primary residence for another.” (1)
1031 Exchange Rules Reminder: “In order to completely avoid paying any taxes upon the sale of your property, the IRS requires the net market value and equity of the property purchased must be the same as, or greater than the property sold. Otherwise, you will not be able to defer 100% of the tax.” (1)
1031 Exchange Rules Reminder: “A Taxpayer Must Not Receive “Boot” from an exchange in order for a Section 1031 exchange to be completely tax-free. Any boot received is taxable to the extent of gain realized on the exchange. In other words, you can carry out a partial 1031 exchange, in which the new property is of lesser value, but this will not be 100% tax free. The difference is called “Boot,” which is the amount you will have to pay capital gains taxes on. This option is completely okay, and often used when a seller wants to make some cash, and is willing to pay some taxes to do so.” (1)
1031 Exchange Rules Reminder: “The tax return, and name appearing on the title of the property being sold, must be the same as the tax return and title holder that buys the new property. However, as an exception to this rule occurs in the case of a single member limited liability company (“smllc”), which is considered a pass-through to the member. Therefore, the smllc may sell the original property, and that sole member may purchase the new property in their individual name.” (1)
1031 Exchange Rules Reminder: “The property owner has 45 calendar days, post-closing of the first property, to identify up to three potential properties of like-kind. This can be really difficult because the deals still need to make sense from a cash perspective. This is true especially in today’s market because people tend to overprice their properties when there are low-interest rates, so finding all the properties you need can be a challenge.” (1)
1031 Exchange Rules Reminder: To qualify under a 1031 exchange, you must also purchase all new properties within 180 calendar days (6 months) following the closing of the original property. An exception to this rule is if the property owner extends his tax return, in which case the 180 day window begins on the date of the extension.
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