CAN YOU TAKE CASH OUT OF A 1031 EXCHANGE?
You cannot take cash out of an exchange without creating a taxable event. If an Exchanger elects to take some of the equity out of the sale proceeds in the way of cash or a note, this is called “BOOT” and is taxable. However, to avoid taxable boot, an Exchanger can opt to refinance after the exchange transaction is completed.
CAN YOU DIRECT DEED WHEN USING AN INTERMEDIARY?
Yes, IRS regulations allow the method known as direct deeding from the grantor to the grantor to the grantee, as in a typical sale transaction. This procedure eliminates payment of additional transfer taxes. Therfore, in most typical exchanges, the deed is prepared as normal with the title conveyed directly from the seller to the buyer.
WHEN IS THE BEST TIME TO NOTIFY THE RELATED PARTIES ABOUT THE INTENT TO COMPLETE A 1031 EXCHANGE?
The IRS requires you to notify the buyer of your relinquished property and the seller of your replacement property of your intent to complete a 1031 Exchange. However, you should wait until all terms of the Agreement of Sale have been agreed upon before making this notification. Ideally, you would like to have the cooperation of your buyer and seller but it is not necessary, as regulations simply require that they be notified in writing.
CAN I CLOSE ON MY REPLACEMENT PROPERTY BEFORE I HAVE A BUYER FOR MY RELINQUISHED PROPERTY?
Yes. This exchange process is known as a REVERSE EXCHANGE. Although, the IRS has not adopted regulations specifically for Reverse Exchanges, they are believed to receive the same benefits as the Deferred Exchange. Currently, there are proposed regulations and case law setting the guidelines we utilize to structure Reverse Exchanges. To make the exchange work, someone other than yourself (usually your intermediary) must take title to one of the properties until you are ready to convey the relinquished property to a buyer.
CAN I MAKE IMPROVEMENTS TO MY REPLACEMENT PROPERTY IN ORDER TO REINVEST ALL SALE PROCEEDS?
Yes. This exchange process is known as CONSTRUCTION or IMPROVEMENT EXCHANGES. To make the exchange work, someone other than you (usually your intermediary) would need to take title to the replacement property, make the improvements identified within your 45-day identification and convey title to you within the 180 day exchange period. Without planning ahead, it is very difficult to complete a construction exchange within the 180-day exchange period. However, properly planned, a construction exchange can be completed successfully.
CAN I EVENTUALLY USE THE REPLACEMENT PROPERTY FOR MY PRIMARY RESIDENCE OR VACATION HOME?
Yes, but you must meet the holding requirement prior to converting the primary use of the property. Although the IRS has no specific regulations on holding periods, it is believed, based on the proposed regulations and case law, that a holding period with a minimum of one year be maintained on both the relinquished and replacement properties. Of course, the longer you hold the property as an investment or business use property, the better, especially when changing your intent of use. It’s strongly recommended holding this property as a rental or business use property for two full years. This must be reported as a rental or business use property on the Exchanger’s tax return, preferably for at least two consecutive years. As your Intermediary,
HOW DO REPORT MY 1031 EXCHANGE TO THE IRS?
Initially, your 1031 Exchange is reported on the IRS form 1099S which should indicate that you are effecting a 1031 Exchange and will receive property as consideration for the sale of your relinquished property. IRS Form 8824 must be completed as part of your annual federal return. In addition to determining your realized gain, recognized gain and your new basis, this form will ask the date you sold your relinquished property, identified and acquired your replacement property. Form 8824 is actually a supporting form for IRS Form 4797. The income received on rental properties must be reported on Schedule D of Form 1040.
DO I NEED TO FIND SOMEONE TO SWAP PROPERTIES WITH?
No, 1031 Exchanges are not really exchanges in the context of two party barter. Instead, you are going to sell your property to someone totally unrelated to the person from whom you are acquiring your replacement property. The only real difference between a 1031 Exchange and a typical sale and purchase transaction is the deferral of capital gains.
IF I HAVE ALREADY SIGNED MY AGREEMENT OF SALE, IS IT TOO LATE TO INITIATE A 1031 EXCHANGE?
No, as long as you have not settled on the property you are selling, a 1031 Exchange can still be completed. However, once the closing occurs, it is too late to utilize the advantages of Section 1031.
WARNING: DO NOT ACCEPT DEPOSIT MONIES MADE PAYABLE TO YOU.
Actual or constructive receipt of any sale proceeds, including good faith deposits, will create a taxable event. Consult a qualified intermediary before accepting a check made payable to you.
ARE 1031 EXCHANGES NEW?
Not at all. The origins of Internal Revenue Code Section 1031 trace back to the Revenue Act of 1921. In 1935, the concept of a multiple party exchange was accepted. The 1970’s and the infamous “Starker Case” made simultaneous exchanges possible. In 1984, “Starker” Exchanges were codified and the 45-day Identification Period and 180-Exchange Period time-lines were born. Finally, in 1991, IRS issued the “safe harbor” regulations and made 1031 regulations easier than ever. Although the West Coast has employed Section 1031 for several decades, the more conservative East Coast is only now beginning to utilize the benefits offered by 1031 Exchanges. 1031 Exchanges are also known as deferred exchanges, Starker Exchanges, real property exchanges and like-kind exchanges.
ADVISORY: EACH EXCHANGE IS DIFFERENT. SEEK COMPETENT ADVICE.
Every Exchange transaction is different. Always consult a competent tax advisor to determine if an Exchange is the best strategy to accomplish your investment objectives. Your tax advisor will be able to analyze your entire situation and advise you accordingly. Additionally, competent legal advice should be sought when necessary.