A 1031 exchange allows the federal and state capital gain and depreciation recapture taxes to be deferred when selling and replacing with property held in the productive use of a business or for investment. There are many rules that must be followed, with one of those being to use a qualified intermediary except in a two party exchange when the exchangor and the buyer want to purchase each other’s property. The qualified intermediary is responsible for generating exchange agreements in accordance with the Internal Revenue Code Section 1031 requirements and holding the exchange funds or net equity from the sale for use by the exchangor to acquire the replacement property.
Access to Exchange Funds
One of the primary reasons the Internal Revenue Service requires the use of a qualified intermediary is to prevent the exchangor from accessing the exchange funds. Known as the (g)(6) requirements, “in no event shall Exchangor receive, pledge, borrow or otherwise obtain the benefits of the Exchange Account, including earnings thereon, before the end of the exchange period.” The exchange funds are typically wired to an escrow account established for the benefit of the exchangor to hold the funds under their tax identification number until needed for the replacement property purchase.
Should the exchangor receive the net equity, either directly or indirectly or deposited into an account they control, the exchange fails. Often calls are received from potential exchangors who have closed on the relinquished or old property and want to know whether they can initiate a 1031 exchange. It is too late because they have access to the funds and the exchange agreements must be signed prior to or on the day of closing.
Timelines
There are two timelines for every 1031 exchange: the 45th and 180th calendar day post-closing when the replacement property candidates must be formally identified — preferably to the qualified intermediary — and the exchange must be completed. If the replacement property is not acquired or identified by the 45th day, the exchange fails and the exchange funds are returned to the exchangor on the next business day. The replacement property must be acquired and conveyed to the exchangor by the 180th calendar day. In a reverse exchange if the replacement property is parked with the Exchange Accommodator Titleholder, the parked property must be conveyed to the exchangor no later than the 185th calendar day.
If multiple properties are identified by the 45th calendar day and the intent is to acquire multiple and only one acquired, the balance of exchange funds (equity boot) is returned to the exchangor post 180th calendar day. If the property cannot be acquired for whatever reason, the funds must be held until the 180th day. The funds are taxed along with the debt (mortgage boot) that was not replaced.
Same Taxpayer
The exchangor who sells or initiates the 1031 exchange must also be the buyer of the replacement property. A wife who is on title to the property sold must be on title to the replacement property, not wife and husband. The husband may be quit claimed onto the property following the 1031 exchange. A single member limited liability company selling cannot be a multi-member limited liability company buying; otherwise, the 1031 exchange fails.
Like Kind
The Internal Revenue 1031 exchange code requires that “property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.” Real property can be exchanged for real property while personal property must be exchanged for like-class or the same asset class of personal property. Property not eligible for 1031 replacement property consideration includes:
- Primary Residence
- Inventory
- Indebtedness
- Securities and Bonds
- Partnership interests
The 1031 exchange is a valuable tax deferral that provides additional working capital for use towards acquiring replacement property. The tax does not go away, but rather is postponed until the replacement property sells when the exchangor can decide whether to initiate another. If the intent is to replace with property, then a 1031 exchange will typically make sense. If the exchangor does not want to own another property, a deferred sales trust allows the net proceeds to be reinvested and the capital gain is taxed when the exchangor receives the principal.
Download the “1031 Exchange Checklist” by clicking here and learn about ten issues to consider when initiating a 1031 exchange.
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.
