International to International Real Property Only
Internal Revenue Code (IRC) Section 1031 applies to all citizens or residents of the United States (US) or non-resident aliens subject to US federal income taxes. Many Exchangors are not aware that international property is eligible for 1031 exchange tax treatment when international property is acquired as replacement property. Though it can be complex, it is possible to execute an international property exchange.
When selling real property held for productive use in a trade, business or for investment, a 1031 exchange allows individuals, partnerships, corporations, limited liability companies and trusts to defer the federal capital gain and recaptured depreciation taxes when selling property held for the proper intent, regardless of where the property is located. Property used predominantly in the US is eligible as replacement for property held in the US, while property located outside the US is eligible for 1031 consideration with property held internationally.
International 1031 Exchange Rules
The 1031 exchange rules for property held internationally are the same as for property located predominantly in the United States. Foreign property is not considered like kind with property held in the US or vice versa. A brief review of the primary exchange rules follows.
Exchange value – to defer the entire gain, the net replacement property purchase price must be equal to or greater than the net relinquished property selling price. Partial exchanges are acceptable.
Timeline – the exchange must be completed within 180 calendar days of the initial closing. The replacement property must be identified, preferably to the Qualified Intermediary, no later than 11:59 PM on the 45th calendar day post-closing.
Same taxpayer – the taxpayer who sells must be the taxpayer who buys with the exception of a disregarded entity, such as a single member limited liability company.
Related party – the relinquished property can be exchanged with a related party given the property is not sold within two years of the transaction; otherwise, the sale triggers the deferred gain. The replacement property can be acquired from a related party if the related party is also initiating a 1031 exchange.
International 1031 Exchange – India Example
What are the steps of a foreign exchange? The answer depends upon whether the exchange funds are held in the country where the relinquished property is sold or in the US. If held in the US, the issue becomes the exchange rate gain/loss when converting to the US Dollar and back to the country where the replacement property is acquired.
The second set of issues impacting the 1031 exchange is the socially accepted norms when buying and selling property. In India, the Buyer will want to pay the Seller directly. There is no closing or escrow company orchestrating the transaction. If the Buyer were to receive the funds from the Seller, then the constructive receipt regulation of the 1031 code would be violated and the exchange fails. Atlas 1031 accommodates the ability for the Seller’s exchange funds to be held in Indian Rupees in an Indian bank under the taxpayer’s permanent identification number, or PAN, requiring two signatures for disbursement, one from the taxpayer and one from the Bank Advocate.
The Bank Advocate cannot be a related party or disqualified person. Prior to disbursing, the disbursement request is initiated and signed by Atlas 1031 Exchange and the taxpayer. The disbursement request is then emailed to the Bank Advocate who interacts with the Bank to access the funds for payment to the Seller.
Plenty of time is required to understand and work through issues. For example, in India, understanding how to accommodate in-country exchanges has taken two years and discussion with chartered accountants and bank officers.
Challenges with International 1031 Exchanges
Constructive Receipt
An international citizen who either maintains US citizenship or is a non-resident alien and is subject to US federal income taxes can initiate a 1031 exchange to defer their US federal capital gain on investment property held internationally. The replacement property can be in the country of origin or elsewhere, though not in the US.
The closing process is different in every country. What we consider standard procedure in the US cannot be assumed in other countries. In a 1031 exchange, if the Seller receives a check, the exchange would be invalidated because the taxpayer has access to the cash, violating the (g)(6) constructive receipt requirement. It is critical for the taxpayer to provide the qualified intermediary access to their financial and legal counsel to discuss sovereign closing procedures.
Holding Exchange Funds Locally
Can funds be held locally in the domestic currency rather than holding them in a US escrow account? This requires the exchange funds be converted to US Dollars and back to the local currency for the replacement property acquisition, risking gain/loss in a currency exchange. Continuing with the Indian example, Indian banks generally do not have three party accounts between the taxpayer, bank and the qualified intermediary. Whose tax identification number is on the account? Stateside, the taxpayer’s tax identification number is a sub-account under the qualified intermediary’s account number. In India, the taxpayer’s Permanent Account Number, or PAN, is used to establish the account with the requirement that disbursement is made with multiple signatures, including one from the taxpayer, qualified intermediary and bank. Once again, working with local officials and a Chartered Accountant in India familiar with the Central Bank is important to secure agreements between participating parties to the 1031 exchange.
If you are considering a 1031 exchange of foreign property, Atlas 1031 provides the accommodation services compliant with Internal Revenue Code Section 1031. Click below to begin a consultation or call our office at 1 800 227 1031 to discuss your international 1031 exchange.
