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Frequently Asked §1031 Exchange Questions

Note:  Many of the following situations are subject to varied interpretations and/or require more detailed information than space allows! Please call for details and check with your CPA or tax attorney before proceeding with your exchange.

Will Your Transaction Qualify as a 1031 Exchange?

Note: Always discuss the transaction with your tax consultant before closing on your sale.

Some basic requirements of a properly structured exchange are:

  • It must be a trade between two parties (Spectrum and the Exchangor are the two parties).
  • Qualified Intermediary must acquire and transfer both the Relinquished and the Replacement Property (done via an Assignment prepared by Spectrum).
  • Exchangor and Qualified Intermediary must enter into an Exchange Agreement outlining the duties and requirements of both parties which includes a restriction on the Exchangor's actual or constructive receipt of the sale proceeds (prepared by Spectrum).
  • Proper identification of potential acquisition properties and completion of the exchange within the prescribed time deadlines (Spectrum will provide detailed instructions and forms). Briefly stated:
  • The exchange period begins the day Spectrum transfers the relinquished property to the new owner. The investor then has 45 days within which to identify potential acquisition properties. Thereafter the actual property(s) must be acquired by Spectrum within 180 days of the sale date or the investor's tax filing deadline, whichever is sooner.
Points to remember:
  • Acquire property equal or greater in value and equal or greater in debt (Note: reduction in debt must be offset by an increase in cash NOT an increase in debt). 
  • Equity not reinvested will be taxable.

The taxpayer is advised to seek the advice of a CPA and/or tax consultant regarding all aspects of a 1031 exchange.  Compliance with the rules and regulations contained in IRC 1031 is the sole responsibility of the taxpayer.

How do I calculate my gain?
Use Our Online Calculator

Start with the price you paid for your property, subtract any depreciation, add any capital improvements. This figure is your adjusted basis. Subtract the adjusted basis and the new costs of sale from the new sales price and the remaining figure is your gain. Expect to pay 20% of that to Federal and State Governments if you do not exchange!

What happens if I go down in value?

If you go down in value, you can still do an exchange to defer a portion of your transaction, however, you will pay taxes on any funds you receive upon completion of the exchange. Closing costs may offset the price differential. You also may wish to acquire more than one property!

Can I exchange my vacation home?

Vacation homes fall under very strict guidelines to determine if they are actually investment property. If you've rented the property out while you owned it, it may qualify for tax deferral. In addition, if you have not personally used the property, you might be able to convince the IRS it was purely held for investment.   Talk with your CPA.

I’m dissolving a partnership, how does that effect the exchange?

The same entity that relinquishes property must acquire property to qualify for an exchange. If some of the partners simply want cash and do not intend to exchange, they can be cashed out when the sale closes and the partnership can remain intact and acquire property. However, if various partners want to go their separate ways but still want to exchange, then the only real option is for the partnership to deed the appropriate percentages to the various partners, before the sale closes. There is a risk in this, however, in that §1031 is for property HELD for productive use in business, trade or for investment purposes. If the partnership deeds to the individual partners, has the property then been "held" by the individuals? Again, talk with your CPA or tax advisor.

What if I live in part of the property?

You can exchange a portion of your property if it has been held for investment purposes. Frequently a farm or ranch falls into this category. A multi-family property might also be part residential and part investment property.

Why does it matter that I’ve gotten married since I bought the property I’m selling?

If you sell a property that you own solely, and your spouse does not have an interest in the old property but does acquire new property with you, the IRS could give you credit for only one-half of the purchase! Depending on the values of the properties involved and whether or not you live in a community property state, this could result in a significant tax bill!

What is "Like-Kind"?

On real property "like-kind" can be any property held for business, trade or for investment purposes! This would exclude only your principal residence for real property exchanges. Like-kind for personal property is much more specific in that a cow can be exchanged for a cow -- not a bull, an airplane for an airplane, etc.

Can I exchange Timber or Water Rights?

If timber rights have been held for a year or more, they can be exchanged for other timber rights. If the trees have not been removed from the property, they may be considered real property and exchangeable for other investment property. Each state handles timber rights differently, however, as a general guideline, if you acquired the timber rights via a deed as opposed to an assignment or bill of sale, they are probably considered real property. Again, state law determines whether or not water rights are real property. If the property was also used for investment purposes, the water rights could be exchangeable. Be sure to consult an attorney who specializes in timber or water rights, in your state, before entering into an exchange of this kind.

What are the time periods for the exchange?

All time periods begin upon the closing of the sale of the relinquished property. The Exchangor must identify the property to be acquired no later than midnight of the 45th calendar day after the close date. The Exchangor must then acquire one of the properties identified not later than midnight on the 180th calendar day following the sale, or the tax filing deadline (including extensions) for the year in which the relinquished property closed. In no event can these deadlines be extended.

What are the rules of identification?

The IRS allows three variations to use when identifying property the Exchangor intends to acquire.

  • Three property rule: Any three properties can be identified (complete address or legal description) and any one or more of these then needs to be acquired.

  • The 200% Rule: The Exchangor may identify as many properties as he desires as long as the total fair market value of the properties does not exceed 200% of the value of the relinquished property.

  • The 95% exception: Automatically used if neither of the above rules apply. Simply stated, the Exchangor must acquire 95% of what was identified! This certainly keeps people from identifying entire blocks of potential properties!

Is a Qualified Intermediary needed if all properties are closing concurrently?

Yes, if there are more than two properties involved. If two Exchangors want each others properties a qualified intermediary is not required. If three or more properties are involved, someone either has to go through the chain of title to make the exchange work or a qualified intermediary must prepare the documents required by the IRS to show the trade.

When can I get my money if I choose not to exchange?

In order to qualify for an exchange, the Exchangor’s access to the funds MUST be restricted by the Qualified Intermediary. IRS Code §1031 clearly states the Exchangor may receive the exchange funds if he fails to identify within 45 days he may receive the funds on the 46th day, or if he fails to acquire property he may receive his funds on the 181st day. There may be some leeway if the Exchangor is unable to acquire property identified due to a material fact beyond the Exchangor’s control, however, this would need to be determined on a case-by-case basis. Of course, if the Exchangor acquires one property and has money remaining those funds will be returned if he lets the Qualified Intermediary know he is done exchanging.

What happens if I forgot to put a cooperation clause into my sales contract?

The cooperation clause is designed to clearly show the Exchangor’s intent to exchange. It is possible to accomplish an exchange by adding this statement after the initial acceptance of the offer, before the sale closes.

Or, to simply have the buyer sign the Assignment of the Purchase Contract prepared by the Qualified Intermediary (which is the extent of cooperation required). Certainly for negotiation purposes, it’s best to get an agreement to cooperate early in the transaction.

Why can’t my real estate agent act as a Qualified Intermediary?

Any agent of the Exchangor’s is disqualified by the IRS to act as a qualified intermediary as well as any related party. If in doubt about whether or not someone is an agent or related party, if he there is a relationship by contract or blood, there is probably a relationship that could disqualify the exchange. With Intermediary fees so reasonable, why risk the possible tax consequences?

Can I borrow against the funds held by the Qualified Intermediary?

Borrowing or pledging the funds would represent the Exchangor’s control of the money, which would make it taxable and would disqualify the exchange.

Can I take money out of the exchange?

The Exchangor may receive funds at the close of the sale escrow, prior to the funds going to the Qualified Intermediary by instructing escrow accordingly. No funds can be disbursed to the Exchangor while held by Qualified Intermediary.

Can I receive the interest on the funds while held?

Any interest earned by the Exchangor can only be disbursed upon completion of the exchange. Otherwise the Exchangor would be benefiting from the funds which would constitute "constructive receipt" of the funds and be taxable. The Qualified Intermediary will issue a 1099 statement for the tax year during which the interest was actually paid to the Exchangor.

Can the Qualified Intermediary advance funds from the exchange for fees and costs needed to acquire the replacement property?

Funds can be disbursed to escrow for earnest money or common expenses such as appraisals and credit reports when the Qualified Intermediary has been Assigned into the transaction in place of the Exchangor.

Funds must be requested by escrow, not the Exchangor to avoid the issue of the Exchangor’s control of the funds. If the Exchangor advances any of these funds they can be reimbursed to him at the close of the escrow without triggering any taxes.

I’ve been asked to carry a loan for my buyer, how does that effect the exchange?

A seller carry-back can be treated as an installment sale or may be deferrable upon certain conditions (call for an in-depth review). The important thing to remember is that the method of handling a carry-back will have important tax ramifications to the Exchangor and the options must be discussed and an action determined BEFORE THE SALE CLOSES.

What is a "reverse" exchange?

Simply stated a reverse exchange is the Exchangor getting what he wants before he’s gotten rid of what he’s got! Click here for detailed flowcharts of the various methods of structuring a reverse exchange.

Can I improve property I already own?

You cannot trade real property for improvements, they are not like-kind. Also, if you own both properties at the same time there can be no trade. Though there have been some recent encouraging court cases, if at all possible do not acquire the replacement property until the improvements have been made. There are ways make the improvements tax deductible -- call for details.

How many properties can I buy or sell in one exchange?

Buy as many as you can afford and can close within the time period. Sell as many as you can provided they can all close within the time periods set by the closing of the first sale.