Tom Gustafson

The acceptance of a purchase and sale agreement begins the often-winding journey towards the sale or acquisition of real property. Commonly, this agreement requires an earnest money deposit (EMD) to solidify the commitment to move forward. Can an EMD be received by an Exchangor who is interested in selling property in a 1031 exchange? Could that Exchangor utilize exchange proceeds towards the EMD for their replacement property? We’ll review a few scenarios below. 

Why is it important to be aware and intentional about how to receive funds as an Exchangor? Regardless of whether or not the earnest money deposit is refundable or non-refundable, an Exchangor should take care in receiving funds so as not to violate the g(6) limitations of constructive or actual receipt of funds.

Receiving an EMD as part of the sale of a Relinquished Property

In the common scenario where an Exchangor receives an EMD as part of the sale of their relinquished property, there are two paths forward. The first path is to have the Title Agency or Closing Attorney hold the EMD in escrow until the relinquished property closes. At this time, along with the rest of the Exchange Proceeds; the funds will be wired to the Qualified Intermediary and in doing so avoid actual or constructive receipt of funds. Generally speaking, an earnest money deposit is not taxable until the transaction has closed or the funds have been forfeited by the buyer.

If the Exchangor holds the EMD in escrow until closing and then combines the EMD with the closing funds to be sent to the QI, they will avoid taxation. The other path would be for the Exchangor to retain the EMD in a personal account and in holding the funds in that way they would be taxable. Most commonly, Exchangors combine the EMD with the additional closing funds provided by the Buyer and utilize them towards their replacement property acquisition.

Can exchange proceeds be used towards an EMD? 

The Exchangor is eligible to utilize their exchange proceeds towards their replacement property’s EMD. In this scenario, the Exchangor will need to first assign the contract to the QI via an Assignment document. Once this is complete, the QI can provide the EMD funds via wire to the appropriate party. If for whatever reason the sale falls through, the EMD funds provided should be returned directly to the QI to avoid actual or constructive receipt.

Can exchange proceeds reimburse my personal funds that I used for an EMD? 

Should the Exchangor decide to utilize their personal funds for the EMD, they are eligible to be reimbursed via exchange proceeds at the closing of the replacement property as long as there are sufficient funds. This is executed at the closing of the replacement property and requires coordination between the Closing Agent and the Qualified Intermediary. Exchange Proceeds cannot be specifically allocated so in order for the personal EMD funds to be refunded, there must be adequate funds to do so. It’s recommended to discuss this with your QI prior to providing the EMD. 

Contact Us

Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 16 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

With many property owners preparing their annual investment strategy this month, we wanted to provide a brief refresher on the basics of a Forward (Delayed) Exchange. We often get asked during the Q&A portion of presentations, “How does a 1031 exchange work?” and we’ve done our best to distill the process down to seven primary steps. Though each exchange is unique and should include the input of the Exchangor’s CPA, there is commonality through most exchanges and that is what we will cover. 

The Top Three Non-Starters for a 1031 Exchange 

While there are many reasons why a 1031 exchange would not work, there are three primary “Non-Starters” that we hear often:

• Primary Residence – Whether an Exchangor is selling a primary residence or selling an investment property to immediately acquire a primary residence, both of these scenarios are not eligible in a 1031 exchange. 
• “I’ve already closed” – If you’ve already closed there is little to no chance that a 1031 exchange is possible as in most cases the Exchangor has either received the funds or had constructive receipt of the funds where they have the authority to direct an agent holding the funds as to how you’d like them used. 
• Second Home / Vacation Home – If an Exchangor has utilized their Investment property more as a second home or vacation home and their “fact pattern” is weak regarding their intent to hold the property for investment purposes, this could be problematic should the property come under IRS audit. 

As mentioned, each scenario is unique. If you fall into one of these three categories and would still like to discuss a potential 1031 exchange, we would be happy to hear your unique situation. Or we can further explain how a 1031 exchange works so you’re better prepared for any future transactions.

The 1031 Exchange Process

If you own real property that has been held for trade, business or investment purposes and you’re considering selling the property to reinvest in other real property to be held for trade, business or investment purposes, the first step towards a successful 1031 exchange would be to speak with and evaluate a credible Qualified Intermediary (QI). Review this brief PDF that outlines four questions that you should ask any QI. Once your QI is selected and they have qualified your transaction, a recommended next beginning step is to speak in detail with your CPA about your transaction. When you are confident that a 1031 exchange is in your best interest, the exchange process will move forward as outlined below. 

The Seven Steps of a Forward (Delayed) 1031 Exchange

1. The Exchangor engages a Qualified Intermediary to accommodate the 1031 exchange by signing an engagement letter and completing a W-9. The W-9 is required by the bank to open a qualified escrow account on behalf of the Exchangor. This must all be done prior to the closing of the Relinquished property. As mentioned earlier, if you’ve already closed there is little chance that a 1031 exchange will be possible. 
2. Sale of the old or relinquished property is negotiated and a Real Estate Sales contract is signed. Remember to include 1031 assignment language in the contract. This is not required, but it is suggested to alert all parties to the sale of the intent to initiate a 1031 exchange. We would be happy to review the contract if there is any question around whether or not the existing language is adequate. It is also recommended that the Exchangor begin looking for suitable replacement properties as early as possible to ease any difficulty of finding property by the 45^thcalendar day. 
3. At the first of two closings, the Exchangor signs the traditional closing documents and 1031 exchange documents. The Buyer will also sign a Notice of Assignment. The IRS requires that all parties to the exchange are notified in writing. 
4. Net 1031 exchange proceeds are wired to a custodial banking partner for deposit into a non-commingled, qualified escrow account under the individual’s social security number or company’s employer identification number. If the Exchangor is not a US citizen, then the funds are wired to an account under their international tax identification number or employer identification number if relinquished property is titled to a foreign corporation. There are IRS rules relating to the Exchangor’s access to these funds during this period. Be sure to discuss these rules with your QI. Additionally, in order to fully defer the capital gains taxes and depreciation recapture, the debt (if any) and the net 1031 exchange proceeds must be replaced in the replacement property. A partial exchange is possible, but clearly does not utilize the full benefit of the tax deferral. Tax is triggered on the partial amount not reinvested.
5. The identification and replacement period begins the day following the closing. The Exchangor must identify the potential replacement properties by the 45th calendar day or the 1031 exchange ends on the 46th calendar day and the 1031 exchange funds are returned to the Exchangor. Replacement property must be purchased within 180 calendar days from closing.
6. Once a suitable replacement property is found, a Real Estate Purchase Agreement is signed by the Exchangor for the replacement property. Remember to include the replacement 1031 assignment language in the contract. The replacement property must be identified on the 45-identification form to the Qualified Intermediary. If the property is not properly identified, it cannot be acquired. 
7. Closing is scheduled where traditional closing documents are signed along with 1031 exchange documents. 1031 exchange proceeds are wired prior to closing. After the closing, the final remaining step is for the QI to prepare a summary of the exchange for the Exchangor and their CPA for use in preparing IRS Form 8824. 

While this is the most distilled version of a Forward (Delayed) Exchange, it does provide a common outline to most exchanges of its kind.  Each possible exchange deserves its own attention and dialogue; however, we would be more than happy to discuss yours with you.

We can help 

Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 16 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

How much does a 1031 exchange cost? Like any unique transaction, the cost for a 1031 exchange varies based on its complexity, the amount of properties bought and sold and even the location of those properties. If just left at that, this article would not be very helpful. We’ll look at a few common scenarios to determine the general fees associated with Delayed and Reverse Exchanges.

Cost and Fees for a Delayed Exchange 

The most common 1031 exchange type is the Delayed (Forward) Exchange. This type of exchange is classified by the selling of the relinquished property first and then acquisition of the replacement property within 180 calendar days. The average fee to accommodate a Delayed Exchange ranges from $750-$1,250. This fee includes the qualifying, accommodation and administrative work of the 1031 exchange. If you were to include additional properties to sell or acquire, the additional property fee could range from $300-$500. Some Qualified Intermediaries will charge more based on the sales price of the properties, but most will fall into the range provided. 

In addition to the set up or administrative fees, most Qualified Intermediaries (QI) earn interest on the exchange proceeds as they’re held in escrow on behalf of the Exchangor. The QI will receive this interest directly from the bank and pay all necessary taxes on the amount. If for example the QI’s bank provides a 1.35% interest rate on the funds, it will equate to roughly $3.75 a day per $100,000 in escrow.  It’s important to understand the full fee structure of the QI that you are engaging when comparing QIs, a lower initial fee may not equate to the lowest fee. 

It’s also advisable to determine if your QI will be charging you for a rush fee to accommodate a last-minute exchange.  Other fees to watch for are wire fees, courier charges or check writing fees. 

Cost and Fees for a Reverse Exchange

In a Reverse Exchange, where the replacement property is acquired prior to the sale of the relinquished property, the fees are typically much higher than a standard Delayed Exchange. Based on the state that the property is held in and judging by the complexity of the reverse exchange, it is best to plan for fees ranging from $3,500 to $7,500. This fee will of course be dictated by the amount of properties sold or acquired and it’s not uncommon for additional properties to range from $400-$600. In addition to this fee will also be the cost of the Delayed (Forward) Exchange that will complete the transaction, bringing the base line closer to $4,500. Though the total cost of a Reverse Exchange can be significant, keep in mind that it gives the Exchangor the peace of mind that they’ve acquired their ideal property first without the concern of identifying property. 

The state where each property is located can also impact the accommodation fee. If the property to be parked with the Exchange Accommodator Titleholder, or EAT, is located in California, the Franchise Tax Board charges $800 for the EAT to do business in California, along with another $70 from the Secretary of State to register the EAT. Each state will typically charge a fee.

This fee structure is similar to a Build to Suit or Construction Exchange and the same general fees should be expected. 

We Can Help 

Atlas 1031 Exchange has increased their fees once in 16 years. We are competitively but moderately priced. If you have any questions around the fees associated with 1031 exchanges, please don’t hesitate to submit a question or begin your consultation above. 

From QI to “like kind” to boot, there is a lot of jargon that is used when executing an Internal Revenue Code Section 1031 Exchange. If it doesn’t make a lot of sense to you, that’s okay; you’re in the majority. We’re going to take a brief look at a few different examples of 1031 exchange boot in this article and how it’s an important term to understand when you’re considering a tax deferred exchange.

What is a 1031 Exchange Boot?

Firstly, let’s review the definition of 1031 exchange. A 1031 exchange allows resident and non-resident United States federal taxpayers to defer capital gains and recaptured deprecation taxes when exchanging real property held for productive use in a trade, business or for investment for like-kind real property held for productive use in a trade, business or for investment. The tax otherwise paid in a traditional sale is deferred indefinitely until the replacement property is sold or another 1031 exchange is initiated. Why would you want to do this? A 1031 exchange gives you the opportunity to utilize funds that would be otherwise unavailable for the acquisition of new investment or business-related real property. Think of it as an interest free loan from the US government.

One of the primary requirements in a 1031 exchange is that in order to fully defer all capital gains taxes and depreciation recapture due, the equity and debt in the replacement (new) property must be equal to or greater than the equity and debt of the relinquished (old) property. Bearing in mind that a partial exchange is possible where the debt and equity is not replaced, the vast majority of Exchangors are executing 1031 exchanges with the intent of fully deferring the taxes due.

By not fully replacing the equity or debt in your replacement property, you would trigger a taxable consequence on the underutilized funds known as Boot. Though there are multiple types of boot, the most common are mortgage boot and equity boot.

What is Mortgage Boot?

Mortgage Boot occurs when the property you acquire has mortgage debt less than the property you relinquished. For example, if you sold an investment property for $300,000 and it had a mortgage worth $125,000 that was paid off at closing and your new replacement property mortgage is only $100,000, you would be subject to taxation on the $25,000 difference. The simplest way to avoid this is to be aware of what your debt requirement is from the beginning and factor it into the replacement property you’re acquiring. One unique aspect of mortgage debt is that it can be offset by additional cash, meaning in the previous scenario, if you were to bring $25,000 worth of non-exchange related funds to the closing, it would satisfy your obligation. Cash can offset debt, debt however cannot offset cash.

What is Equity Boot?

Equity or Cash Boot occurs when equity, cash or any cash equivalent received as part of the sale of the relinquished property is not replaced fully in the replacement property. In some instances, Exchangors will receive equity at the closing of their relinquished property as part of their overall strategy; the portion received is subject to taxation and is considered Equity or Cash Boot. For example, if you sold your investment property for $300,000 and paid off the $125,000 mortgage, after closing costs you would determine your net sales proceeds. Let’s say that the net sales proceeds for this sale are $150,000. The Exchangor is welcome to receive any portion of those funds at closing, but by receiving them will trigger a taxable consequence. Keep in mind that the more funds received reduces the benefit of the 1031 exchange and could potentially render the 1031 exchange useless. Being aware of these common types of boot from the onset of your exchange will help you determine if you want to strategically utilize boot or avoid it at all costs in your 1031 exchange. Once your relinquished property sells, it is a best practice to review the equity and debt requirements with your Qualified Intermediary so that you’re well aware of what needs to be reinvested in the replacement property.

Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 16 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange whether you want to receive boot or avoid it at all costs. Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the form.

In any I.R.C. § 1031 Exchange, the correct and timely identification of replacement property is essential. Though there are a litany of 1031 exchange identification rules and regulations that must be followed exactly, there are some basics that must be understood from the beginning in order to execute a successful exchange. In a Forward (Delayed) Exchange, the Exchangor has a 45-day window after the closing of their relinquished property to identify potential replacement properties.  This is commonly known as the “Identification Period.”  Continue reading →