When taxpayers are considering a 1031 exchange, there are four initial suggested steps. Often times, the question is asked when is it too late for a 1031 exchange. The answer is when the net proceeds have been received from the sale–either directly or indirectly–such as deposited into your account. If the buyer is willing, you can potentially unwind the transaction, including not recording or re-recording the title to your name and returning the funds to the buyer. If a lender is involved, then the probability of rescinding the closing is quite low.
1031 Exchange
The first step is taking ownership of understanding a 1031 exchange, including the basic rules, to determine whether you qualify. A 1031 exchange allows taxpayers to defer the gain or loss when selling real or personal property held in the productive use of a trade, business or investment and replacing with like-kind real or personal property of equal or greater value within 180 calendar days of the initial closing. Property excluded from 1031 consideration includes primary residence, inventory, partnership interests, indebtedness and securities and bonds. If the relinquished property is a vacation property, consider if your personal use been 14 overnights or ten percent of the time rented or less in the past year; otherwise, the property appears to be a second home, reported on Schedule A of your federal tax return and is not eligible for a 1031 exchange.
Eligible 1031 property includes any real estate or personal property, such as aircraft, furniture, gold and silver bullion, thoroughbred show horses, fast food restaurants, vintage and classic cars, artwork and heavy construction equipment. Lessees of long term 30 plus year leases can sell their interest and exchange for real property interests.
CPA Input
The second step is to visit with your CPA to confirm the tax consequences of the sale. Your CPA will understand whether you may have losses to offset the gain. The CPA will complete and sign the IRS Form 8824 reporting the 1031 exchange along with your federal return, so it is best to get their approval of the 1031 exchange before rather than after the fact.
Engage a Qualified Intermediary
The final step before initiating a 1031 exchange is to vet and engage a Qualified Intermediary (QI). The QI is responsible for creating the 1031 exchange agreements in accordance with the Internal Revenue Code and holding your exchange proceeds in a manner that preserves principal and liquidity. Get to know your QI by asking a series of questions about their experience, knowledge, procedures and the bank to hold your proceeds. Is a Qualified Escrow Account requiring dual signatures authorizing disbursement required? Is interest paid? Is the QI accommodating your exchange a Certified Exchange Specialist®?
Assignment Language
Let your Realtor know your intent to initiate a 1031 exchange by including assignment language in the Purchase and Sale Agreement. All parties to the 1031 exchange are required to be informed in writing that a 1031 exchange has been initiated. In the closings, assignments and notice of assignments are prepared for the buyer, co-buyer, seller and co-seller to sign. If the assignments are not created or signed, the exchange may be deemed by the IRS to be outside the safe harbor and void.
There is much to learn about a 1031 exchange. Your QI will be on the alert for potential rule violations and make sure the 45th calendar day property identification is completed. Those taxpayers who do not take ownership of learning about 1031 exchanges and asking lots of questions allow the potential for 1031 exchange surprises to happen.
To learn more about what questions to ask a QI during the vetting stage, click the button below.
