Given the property titleholder is subject to US federal capital gain taxes, a foreign 1031 exchange is a recognized tax deferral strategy that both the foreign and domestic taxpayer should utilize when replacing like kind real, tangible and intangible personal property. For example, a US taxpayer selling a property held in the productive use of a business or investment in China can exchange for property held in the productive use of a business or investment in Japan. Property held outside the US is considered like kind with any property held internationally. US property predominantly held in the US is not eligible for replacement property held outside the US and vice versa. Israel is experiencing an appreciating real estate market with many 1031 exchanges being initiated selling and replacing with Israeli real property.
1031 Exchange Rules
The same set of Internal Revenue Code Section 1031 rules apply to every exchange whether domestic or foreign. Exchanges outside the US face challenges, particularly with social customs and banking requirements. The g(6) limitations of the 1031 code known as constructive receipt is one of those challenges. The taxpayer cannot have access to the net proceeds of the sale. If the taxpayer does, then the exchange is over, nullified. One of the primary reasons why a Qualified Intermediary (QI) is required to accommodate the exchange is to be an independent, third party that separates the taxpayer from their exchange funds. The QI should extend maximum effort to understand the country’s banking requirements to offer alternatives to either hold the exchange funds in the sovereign currency or convert to US Dollars and hold in a US bank. When exchange funds are converted to and from the US Dollar, the principal is at risk to exchange rate loss and or gain.
In India, the social custom is for the Buyer to provide the Seller with the exchange funds in a setting characterized by standing in line at a bus station to transfer title. Care must be afforded to persuade the Seller to follow instructions to deposit the funds in such a way as to not allow the Seller or taxpayer to touch the funds. Given the large Indian black market, many real estate sales go unreported, diminishing the use of 1031 exchanges.
Pre-construction options are common for the replacement property when the taxpayer wishes to acquire an investment property in an uncompleted project. The intent is to acquire property title once the unit is completed. The 1031 exchange rule requires replacement property title is received. Title is not conveyed typically until after a Certificate of Occupancy is provided which could be two to three years after the option to acquire is initiated. Given the 180 calendar day limitation of the 1031 code, pre-construction options are not possible unless title can be conveyed to the taxpayer within the 1031 timeline requirement.
To open foreign bank accounts to allow the QI to hold the exchange funds for the taxpayer, the QI must be registered in that country. In turn, the QI opens a sub-account under the tax identification number of the taxpayer. The exchange funds are not the QI’s property but the taxpayer’s and should never be held in the operating account of the QI but a separate non-commingled account. In Israel, sales take time with payments made in installments allowing for debt, if any, to be retired and property taxes paid. To hold exchange funds in Israel Shekels in an Israeli bank is doable with the assistance of local professionals.
Personal Property
Personal property 1031 exchanges look back to the predominant use over the two years prior to closing. If the property has held at least a year and a day overseas, then the replacement property must be held internationally. This applies to aircraft, vessels, thoroughbred horses, gold and silver bullion, numismatic coins, vintage cars and artwork.
If you have a question regarding a foreign exchange, click on the button at the top of the page and anticipate a response within twelve hours or less from our team. Foreign exchanges can be challenging; however, with local assistance they can be completed and capital gain tax deferred.
We Can Help
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.
