In the seemingly complex world of 1031 exchanges, sometimes it helps to hear how others have navigated their exchange. In the following example, we follow a basic transaction that represents the general sequence from start to finish. This example is purely for relatability purposes and was kept simple with the intention of showing a common scenario. Every 1031 exchange is unique; however, there are common guidelines that must be followed in order to successfully execute the transaction from start to finish.
Zac and Stephanie Burke purchased a rental property in New Smyrna Beach, Florida in February of 2016 for $250,000. They held this property and rented it out to vacationers from the time they purchased it up until they put it on the market in March of 2019. With a confirmed sales contract for $375,000, they knew they would have a significant taxable obligation.
As soon as they began working with their Realtor, he mentioned to them that they should consider a 1031 exchange as the Burke’s intent was to sell their New Smyrna Beach rental property to acquire a duplex near a local University that would also serve as an income generating rental property. After conferring with their CPA they decided that a 1031 would be in their best interest and that the deferral of the capital gain and depreciation recapture due would be worthwhile based on their intent to reinvest in a more appropriate investment property.
After discussing their usage of the property with a Qualified Intermediary, they determined their property was 1031 eligible. In this conversation, they discussed the amount of time they personally used the property, which amounted to roughly 10 days in each of the previous two years and the rental amounts which they estimated were roughly 150 rental nights in each of those years. In limiting their personal usage and renting more than 14 overnights in each of the previous years, as well as the fact that they had owned the property for more than two years prior to the sale, the Burkes satisfied the IRS criteria in Rev. Proc 2008-16 and therefore their property was 1031 eligible.
In advance of the closing date, the Burkes connected their Qualified Intermediary with the Title Agent who would be handling the closing of their New Smyrna Beach property. During this time, they continued to search for potential replacement properties with their Realtor so as to give themselves the most time to review potential replacement property options.
Once their property closed on May 1, 2019, two concurrent schedules began. First, the 45-day identification period, or the period in which the Burkes were able to identify the properties that they intended to acquire. Secondly, their 180-day exchange period began when the old property closed; this is the timeframe to close on the property identified during their 45-day period. Based on the closing statement, the Burkes, along with their Qualified Intermediary, were able to determine the amount that would need to be reinvested into their replacement property in order to maximize their deferral and ensure that their taxable obligation would not come due.
With a sales price of $375,000 and closing costs of $10,000, the net sales price of their relinquished property equated to $365,000.00. They had a $100,000 mortgage on their relinquished property that was retired at closing; however, both the debt and equity (exchange proceeds) need to be reinvested in their replacement property. In the Burkes’ case, they need to reinvest the $100,000 in debt and the $265,000 of exchange proceeds into their replacement property. With this figure solidified, they began to focus on a group of duplexes that were equal or greater than $365,000.
After a month of vetting possible replacement properties, the Burkes extended an offer on the duplex that they felt was their first choice. As the 45-day ID window of June 15th drew close, their QI encouraged them to add a second property as a contingency just in case there was an issue with their first choice. On June 12th, the Burkes submitted their ID letter with both choices included and indicated that they would only be acquiring one of the properties. In doing so, they submitted their ID letter ahead of the 45-day deadline and met the IRS requirement.
On July 20th, they were surprised when their first-choice duplex unfortunately did not pass inspection and they were not able to move forward with it. Thankfully, they had identified a second property and immediately reached out to the listing agent. Within 48 hours, they extended a contract on the property at a listing price of $395,000. Had the Burkes not included a second property, they would not have been able to move forward with their exchange, as properties cannot be acquired that are not identified by the 45thcalendar day.
The Burkes connected their QI with the Closing Agent for their replacement property and all IRS required documentation was created prior to the closing. Their exchange proceeds were sent in via wire and their closing was a success. As the sales price of the Duplex was greater than the $365,000 net sales price of their relinquished property, they were able to bring a small amount of personal capital to the closing and defer all of their taxable obligation.
After their closing on August 1st, their QI created a PDF summary of their transaction for their records and sent a copy to both the Burkes and their CPA.
In this 1031 example, the Burkes benefitted from identifying multiple potential replacement properties. Every 1031 exchange is unique but their situation allows for a narrative view of a common exchange scenario.
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Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 17 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.
