Internal Revenue Code Section 1031
provides that no gain or loss will be recognized on the
exchange of any type of business use or investment property
for any other business use or investment property.
The general rule in order to have
a fully deferred exchange is that you must trade equal
or up in equity and equal or up in fair market value.
The effect of this rule is that you must use the entire
net proceeds from the relinquished property as down payment
on the replacement property. Also, you must replace any
mortgage paid off at the sale of the relinquished property
with an equal or greater mortgage on the replacement property.
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. To avoid taxable boot an Exchanger should
opt to refinance after the exchange transaction is completed
rather than take cash out of the sale proceeds.
If the exchanger receives cash
upon the sale of the relinquished property this is "boot"
and this amount will be taxed. If the exchanger fails
to purchase a replacement property of equal or greater
value than the relinquished property there is a strong
possibility that he will be deemed to have received mortgage
"boot." An exchanger can also receive other
property which will be deemed boot.
For example, if the exchanger receives an automobile,
art work, or any other thing of value as part of an exchange,
that other non-like kind property will be deemed boot
and taxed on the fair market value of the other property
When it comes to real estate, all
property is like kind to all other real estate. For example,
farm land can be exchanged for an office building, a condominium
can be exchanges for a trailer park. Certain other tangible
personal property can be exchanged, like airplanes and
equipment. Whether this property is like kind is determined
by reference to certain industrial classifications.
The replacement properties must
be identified within 45 days after the sale of the relinquished
property. This requirement is strictly enforced, even
if the 45th day falls on a holiday. Identification must
be in writing, signed and dated by the exchanger and received
by the QI no later than 45 days after the sale of the
relinquished property. Replacement property must be identified
unambiguously. Usually either a legal description or a
mailing address is sufficient. The replacement property
must be purchased within 180 days after the sale of the
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 recommended that the property
should be held for its intended use for at least two tax
returns. Of course, the longer you hold the property as
an investment or business use property, the better, especially
when changing your intent of use.
Title to the replacement property
must be taken in the same name in which the relinquished
property was held.
Yes. A fractional part or undivided
Tenant in Common (TIC) interest in the relinquished property
may be exchanged and/or a fractional part of the replacement
property may be acquired. Interests in Partnerships, Corporations,
LLCs or REITS do not qualify.
Yes. Several relinquished properties
may be exchanged for a single replacement property. One
relinquished property may be exchanged for several replacement
properties. The important thing is that the exchange be
part of a unified exchange agreement from the beginning.
The 45 day identification rule and 180 day replacement
rule will start running from the date of the sale of the
first relinquished property. Sometimes because of this
timing issue it is better to structure the exchange as
a series of exchanges rather than a multiple leg exchange.
No. Tax basis from the relinquished
property is carried forward into the replacement property.
Tax basis in the replacement property is increased by
any additional cash or increase in mortgage by the exchanger.
Once a depreciation allowance is taken on the relinquished
property it may not be used a second time on the replacement
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
Yes. This exchange process is known
as a Reverse
Deferred gain: Amount of "realized
gain" that is not currently taxable.
Like Kind: No gain or loss shall be recognized
on the exchange of property held for productive use in
a trade or business or for investment if such property
is exchanged solely for 'like-kind' property which is
to be held either for productive use in a trade or business
or for investment.
Qualified Intermediary: A third party
or facilitator who is an independent principal who assists
in completing a successful section 1031 tax-deferred exchange.
Realized gain: Difference between sales
prices and adjusted tax basis.
Recognized gain: Amount of "realized
gain" that is currently taxable.
Replacement Property: The property the Exchanger is buying. Also called new property.
Relinquished Property:The property the Exchange is selling. Also called the old property.
Section 1031: Section 1031 of the Internal
Revenue code provides that tax on gain from the sale of
real or personal property held for investment or business
purposes can be deferred if the property is exchanged
(rather than sold) for other like-kind property.