Investors Information

What is a 1031 Exchange?

A 1031 Tax Deferred Exchange offers taxpayers one of the last great opportunities to build wealth and save taxes. By completing an exchange, the Taxpayer (“Exchanger”) can dispose of investment or business-use assets, acquire replacement property and defer the tax that would ordinarily be due upon the sale.

1031 refers to section 1031 of Internal Revenue Code. A 1031 Exchange allows people to defer Federal capital gains tax, state ordinary income tax, net investment income tax, and depreciation recapture on the sale of Investment property if certain criteria are met including:

• Buy replacement property for equal or greater than sold for and reinvest all proceeds

• Identify replacement property within 45 days of close of sale

• Purchase replacement property within 180 days of close of sale

• Must Sell and Buy property that is considered “like-kind” to each other

• Process must be handled by a Qualified Intermediary

What is a Reverse 1031 Exchange?

If you find a replacement property that you would like to acquire before you sell your current property, you can utilize a Reverse Exchange to maximize your tax deferral. If you would like to build on or make improvements to a replacement property, you can use the exchange proceeds by structuring an Improvement (Build-to-Suit or Construction) Exchange. Also known as “parking” transactions, both Reverse and Improvement Exchanges are two of the more complex yet highly useful exchange structures available.

Qualified “like kind” properties

There is a two-pronged test for properties to qualify for IRC §1031 tax-deferral treatment.

1. Both the Relinquished and the Replacement Properties must be held by the Exchanger either for investment purposes or for productive use in a trade or business. The Exchanger’s purpose and intent in holding the property is the critical test. The use of the property by other parties to the exchange (Relinquished Property buyer or Replacement Property seller) is irrelevant.

2. The Relinquished and the Replacement Properties must also be “like-kind.” The term “like-kind” refers to the nature or character of the property, ignoring differences of grade or quality. For example, unimproved real property is considered like-kind to improved real property, because the lack of improvements is a distinction of grade or quality; the basic real estate nature of both parcels is the same. Treas. Reg. §1.1031(a)-1(b). In essence, all real property in the United States is “like-kind” to all other domestic real property.

IRC § 1031(a)(2) specifically provides that real property held primarily for sale does not qualify for tax deferral under section 1031.

Following are examples of qualifying properties that could be exchanged:

• Raw land or farmland for improved real estate

• Oil & gas royalties for a ranch

• Fee simple interest in real estate for a 30-year leasehold or a Tenant-in-Common interest in real estate

• Residential, Commercial, Industrial or Retail rental properties for any other real estate

• Rental ski condo for a three-unit apartment building

• Mitigation credits for restoring wetlands for other mitigation credits

Under IRC §1031, the following properties do not qualify for tax-deferred exchange treatment:

• Stock in trade or other property held primarily for sale (i.e. property held by a developer, “flipper” or other dealer)

• Securities or other evidences of indebtedness or interest

• Stocks, bonds, or notes

• Certificates of trust or beneficial interests

• Interests in a partnership

• Choses in action (rights to receive money or other property by judicial proceeding)

• Foreign real property for U.S. real property

• Goodwill of one business for goodwill of another business

1031 Exchange Deadlines & Rules

There are two key deadlines that the Exchanger must meet to have a valid exchange:

• Identification Period: Within 45 calendar days of the transfer of the first Relinquished Property, the Exchanger must identify the Replacement Property to be acquired.

• Exchange Period: The Exchanger must receive the Replacement Property within the earlier of 180 calendar days after the date on which the Exchanger transferred the first Relinquished Property, or the due date (including extensions) for the Exchanger’s tax return for the tax year in which the transfer of the first Relinquished Property occurs.

• The time periods for the 45-day Identification Period and the 180-day Exchange Period are very strict and cannot be extended even if the 45th day or 180th day falls on a Saturday, Sunday or legal holiday. They may, however, be extended by up to 120 days if the Exchanger qualifies for a disaster extension under Rev. Proc. 2007-56.