1031 Exchange Blog

Over the past 17 years, we have had the pleasure of guiding thousands of Exchangors through the 1031 Exchange process. Our Blog draws from that experience and includes content ranging from the basics of an Exchange for first time Exchangors to detailed commentary on complex exchanges for the expert investor. If you do not find the topic or specific question you are looking for, reach out to us via email at info@atlas1031.com or call our office to speak with our team at 1 800 227 1031.

Partial 1031 Exchange

Posted on | by Andy Gustafson | Leave a Comment on Partial 1031 Exchange

A 1031 exchange is based upon the premise that the replacement property acquired is of equal or greater value than the property sold. A pervasive misconception regarding 1031 exchanges is that you MUST reinvest all exchange proceeds and debt, it is not required however it is encouraged in order to optimize the tax deferral potential. Partial 1031 exchanges are when the taxpayer does not use all the net equity and debt retired in the new property. Cash received (equity boot) or debt not replaced (mortgage boot) is taxable. Given the taxpayer’s intent to receive cash, the best time to receive it is at the initial closing. An alternative is to do a post-exchange refinance accessing cash, not paying the tax by increasing debt.

Critical Error to Avoid in a Partial 1031 Exchange

Partial exchanges are popular, but in some cases a 1031 exchange may not make sense. The taxpayer will start deferring gain only when he has acquired replacement property, the value of which exceeds his basis in the relinquished property. If not, the tax triggered on the boot may be close to the tax due if no exchange was initiated. In other words, you pay the qualified intermediary to accommodate the 1031 exchange, identify and acquire replacement property all to discover later that the tax triggered on the cash received or debt not replaced is not much different if the tax was paid on the sale without a 1031 exchange.

Equity and mortgage boot are taxable given the Internal Revenue Service considers them benefits received. Cash received or debt not replaced on the new property is not equal to or greater than on the old property changes the taxpayer’s economic position. Additional cash always offsets debt, but additional debt does not offset cash. The reason for the tax deferral is that the taxpayer is reinvesting all their net equity and the replacing the debt retired in the replacement property; consequently, no gain is recognized.  

CPA Input

When considering a partial 1031 exchange, seek the input of your CPA to determine the tax due in a sale without a 1031 exchange. Next, what is the tax due on cash received or debt not replaced? This will save the angst and gnashing of teeth wondering why your qualified intermediary did not suggest that a 1031 exchange may not make sense. The qualified intermediary is not required to challenge the taxpayer’s intent to pay their fee. This should give rise to whose interest the qualified intermediary is serving. Perhaps it is time to find another qualified intermediary.

What is a 1031 Exchange?

For those not familiar with a 1031 exchange, the Internal Revenue Code Section allows taxpayers to defer the federal and state capital gain and depreciation recapture taxes on the sale of real property held in the productive use of a business or investment when “like-kind” property is replaced. Real property can be exchanged for any real property. There are many rules to be followed with one of those to use a qualified intermediary to facilitate the 1031 exchange. Generally, anyone who has acted as the agent of the taxpayer in the previous two years is disqualified from being the taxpayer’s qualified intermediary. There are exceptions.

The typical exchange is initiated by individuals, husband and wives, trusts and companies on transactions where the old property sells for $300,000 or less. Primary residences, partnership interests, indebtedness, stocks and securities and inventory are not eligible for the tax deferral. Farms and ranches are eligible and should the farm house represent the primary residence, Section 121 covers the house and the land is sold in a 1031 exchange deferring the recognized gain on the land.

Contact Us

Download “Ten Reasons Why a 1031 Exchange Makes Sense” by clicking here. If you have a comment, we would enjoy hearing from you. If you have any questions, feel free to reach out to us via the options on the top right of this page, call our office at 800-227-1031 or contact us via email.

1031 Exchange Rules Oregon

Posted on | by Andy Gustafson | Leave a Comment on 1031 Exchange Rules Oregon

Property owners in Oregon who wish to defer capital gains taxes on the sale of property may be able to do so by entering into a Section 1031 Exchange agreement instead of completing a traditional sale under the rules of the Internal Revenue Service. In an effort to ensure that 1031 Exchanges comply with the complex, and ever changing, rules, as well as to safeguard funds and ownership documents during an exchange, participants in a 1031 Exchange are required to use a Qualified Intermediary, or QI, to complete the transaction.

The role of the QI is one of a facilitator, meaning that the QI takes possession of titles and funds and distributes them to the appropriate parties at the appropriate time. Because a QI acts in a fiduciary role, many individual states have passed legislation in addition to that found under the federal rules that further dictates the duties and responsibilities of a QI. Oregon is one of those states; however, in Oregon a Qualified Intermediary is referred to as an Exchange Facilitator, or EF. Your EF will be your guide to ensure all rules and requirements of a 1031 exchange are followed.

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Earnest Money Deposits in a 1031 Exchange

Posted on | by Tom Gustafson | Leave a Comment on Earnest Money Deposits in a 1031 Exchange

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.

1031 Exchange Rules California

Posted on | by Tom Gustafson | Leave a Comment on 1031 Exchange Rules California

Before outlining the specific 1031 exchange rules in California, let’s first introduce the basic concept of a 1031 exchange. In a traditional sale of property, a seller is required to pay capital gains taxes on any gain realized in the sale. One way to avoid paying capital gains taxes is to defer payment by entering into a Section 1031 Exchange. As the name implies, a 1031 Exchange contemplates an “exchange” of like-kind property instead of a traditional sale. If the transaction qualifies, any realized gain is deferred until the replacement property is sold at a later date. One common misconception is that property sold in California must be replaced by property in California, this is not true. The “like-kind” requirement is very general and allows for an Exchangor to acquire property outside of California should they wish to do so. 

The Internal Revenue Service Code sets forth the requirements that must be met in order for a transaction to benefit from 1031 Exchange treatment. In addition to the requirements found in the IRS Code, Qualified Intermediaries must follow additional rules legislated by the State of California for exchanges where the old or relinquished property or the property parked with the Exchange Accommodator Titleholder is located in California.

How does a 1031 exchange work in California? The 1031 exchange rules in California state in general, that anyone who facilitates an exchange for a fee, maintains an office in the state for the purpose of facilitating exchanges, or advertises services as a facilitator in the state, is required to follow the California specific rules.

A Qualified Intermediary operating in California must maintain a bond in the amount of $1 million, deposit an amount of cash or securities or irrevocable letters of credit in an amount not less than $1 million, or deposit all exchange funds in a qualified escrow account or trust account. Anyone who has sustained damages as a result of a facilitator’s violation of the California 1031 exchange rules may make a claim against the bond, account or trust.

In addition, a Qualified Intermediary operating in California must maintain an errors and omissions policy of not less than $250,000 or must deposit cash, securities, or letters of credit in an account designated for the same purpose. Finally, a Qualified Intermediary in California must act as a custodian for all exchange funds and must invest those funds pursuant to a prudent investor standard.

The California Franchise Tax Board also requires a Qualified Intermediary, in most cases, to withhold an amount equal to three and one-third percent of the sales price of any California property as contingency should the exchange not be completed.

Clawback Provision

California has a “clawback” requirement for California property sold in a 1031 exchange and replaced with an out of state replacement property per California FTB Publication 3840. Non-residents are required to file a nonresident income tax return in the year the replacement property is sold in a taxable disposition.

Interested in learning more about when a 1031 exchange makes sense? Click here to download a complimentary eBook on “Ten Reasons Why a 1031 Exchange Makes Sense”.

We strongly recommend conferring with your CPA prior to engaging in a 1031 exchange. It is valuable to have the support and insight of your CPA when making the decision whether or not to proceed with an exchange.

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How Does a 1031 Exchange Work?

Posted on | by Tom Gustafson | Leave a Comment on How Does a 1031 Exchange Work?

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 45thcalendar 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?

Posted on | by Tom Gustafson | Leave a Comment on How Much Does a 1031 Exchange Cost?

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.