Common
§1031 Exchange Questions
The questions you may have regarding §1031 exchanges are
important to discuss. Here are a few of the most common
questions asked and a brief response. This information
is not intended to provide legal or accounting advice.
Your tax accountant or attorney is the best source for
meeting specific investment needs.
The regulations state that I must exchange my
property for “like kind” property. What does the IRS
consider “like kind” real property?
Regulations allow the taxpayer to defer taxable gain if
the relinquished property is exchanged for replacement
property that is of the same nature or character. Grade
or quality is insignificant. In other words, all real
estate is like kind to all other real estate, whether
improved or unimproved. Bare land can be exchanged for a
single-family rental, or an office building, or a
30-year leasehold, or a four-plex. Remember, in a §1031
exchange the exchange is of properties used in a trade
or business or for investment, not of properties
intended for personal use (primary residence) or
inventory (property held for resale purposes). Real
property is not considered like-kind to personal
property.
What value does the replacement property have to be
to defer the taxable gain from the sale of my
relinquished property?
Generally, to defer all taxable gain, the value of the
replacement property must be equal to or greater than
the value of the relinquished property, and all cash
proceeds from the sale of relinquished property must be
used to purchase the replacement property, and the value
of the debt paid at the closing of the relinquished
property must be replaced with equal or greater debt on
the replacement property. Regulations will allow the
taxpayer to provide additional cash investment to be
used in place of new debt. Value not reinvested in
replacement property is “boot” to the exchange and is
taxed.
What are the deadlines for a §1031 exchange and when
do they start?
There are two important deadlines in §1031 tax deferred
exchanges and they both begin on the same day, the day
the ownership of the relinquished property is
transferred to the buyer. From that date, the taxpayer
has 45 days to identify potential replacement property,
and 180 days to acquire the identified property, or the
due date for filing the tax return for the year in which
the relinquished property was sold, whichever is first.
As an example, if an individual taxpayer’s transfer of
relinquished property occurred on November 1, 2000, the
replacement property must be acquired by April 15, 2001,
the date the taxpayer’s income tax return is due; Or the
taxpayer can file an extension and use the remaining
days of the 180-day exchange period to complete the
acquisition (which would end April 30, 2001).
How do I identify replacement property?
Identification of replacement property can be as simple
as writing a letter to Jeld-Wen 1031 naming the property by street
address, legal description or distinguishable name.
Regulations state that the identification must be (1) in
writing, (2) signed by the taxpayer, and (3) delivered
to the person obligated to transfer the replacement
property to the taxpayer (generally the Qualified
Intermediary-Jeld-Wen 1031) or any other person involved in the
exchange other than the taxpayer or a disqualified
person. Exchangers acquiring a property, which is being
constructed, must identify the real property together
with the improvements to be constructed in as much
detail as is practical. Exchangers who intend to acquire
less than a 100% ownership interest in the replacement
property should specify the specific percentage
interest. Following the closing for the sale of the
relinquished property, Jeld-Wen 1031 will provide a form letter
that can be used for identifying replacement property.
How many properties can I identify?
The taxpayer can choose from three rules:
1. Three Property Rule. Under the three-property rule,
the taxpayer can name three potential replacement
properties without regard to fair market values of the
properties. One, two or all three properties may be
acquired.
2. 200 Percent Rule. Under the 200% rule, the taxpayer
can name more than three properties as long as the
aggregate fair market value of the properties does not
exceed 200% of the aggregate fair market value of the
relinquished property. (Example: Relinquished Property
sold for $300,000. Taxpayer may identify four or more
replacement properties as long as the value of all
identified replacement properties combined does not
exceed $600,000.)
3. 95 Percent Rule. Any number of properties can be
identified without regard to the combined fair market
value, as long the as the properties acquired amount to
at least ninety-five percent (95%) of the fair market
value of all identified properties. (This rule is seldom
used).
Can I file for an extension if I am unable to
complete my identification by the 45th day or complete
the acquisition by the 180th day?
Extensions for the deadlines for §1031 exchanges are not
allowed. The identification MUST be completed by
midnight of the 45th day, and the purchase of all
replacement properties MUST be completed by midnight of
the 180th day following transfer of ownership of the
relinquished property. If the deadlines fall on a
weekend or holiday, the taxpayer must complete
transactions on the business day prior to the deadline.
What information do I need to include in my listing
agreement or a sales contract when I intend to include
the sale of my property in a §1031 exchange?
Though not legally required, including a disclosure
establishes intent to exchange for audit purposes. The
following is an example of a cooperation clause that may
be used:
“Buyer hereby acknowledges that it is the intention of
the Seller to complete an IRC Section 1031 exchange that
will not delay the close of escrow or cause additional
expense or liability to Buyer. Buyer agrees to cooperate
with the Seller and an Intermediary of Seller’s choice
in a manner necessary to complete the exchange.”
Can an Exchanger carry a note on the Relinquished
Property?
The Exchanger may elect to carry-back a note on the
Relinquished Property and receive the proceeds as
payments are being made. The Exchanger will pay taxes on
that portion of the capital gain under the installment
method. If the Exchanger elects to have the note as part
of the exchange the note will be held in the name of Jeld-Wen 1031
and then sold to a third party for cash or assigned to
the seller of the Replacement Property and used as part
of the purchase price. The Exchanger may also elect to
purchase the note from Jeld-Wen 1031 and deposit cash equal to the
face value of the note with Jeld-Wen 1031. It is critical that the
structuring of the note is properly accomplished without
jeopardizing the tax benefits.
Can the Replacement Property be under construction or
in the planning stage?
Yes. The Improvement Exchange allows an investor through
the use of Jeld-Wen 1031 to make improvements on a replacement
property using exchange funds, although it must be
acquired by the Exchanger on or before the 180th day.
The Exchanger must spend the entire exchange equity on
completed improvements by the 180th day, receive
substantially the same property as identified and the
replacement property must be equal or greater value at
the time of transfer to the Exchanger. It is possible to
close in an incomplete state although the property would
need to be appraised as such and the tax basis
calculated per the unfinished value. Identification is
critical in an Improvement Exchange. The land must be
identified together with the capital improvements that
are to be completed in as much detail that is practical.
There are numerous ways an Improvement Exchange can be
structured. The advice and guidance from your attorney
and/or accountant should be considered.
What is a Reverse Exchange?
A Reverse Exchange occurs when the Replacement Property
is acquired prior to the closing of the Relinquished
Property. The reverse exchange is a ‘parking
arrangement’ that allows an Exchanger to purchase a
replacement property and then later sell the
relinquished property within 180 days. Revenue Procedure
2000-37 enacted on September 15, 2000 creates a safe
harbor for reverse and improvement exchanges whereby the
“Exchange Accommodation Titleholder” (Jeld-Wen 1031) enters into a
parking arrangement and acquires title to either the
relinquished property or replacement property. Several
reverse exchange strategies are available:
• Parking the Replacement Property
• Parking the Relinquished Property
• Reverse/Improvement Exchange
Strategically applied these types of exchanges empower
the investor with the ability to enhance their
investment alternatives.
What should I look for in an Intermediary?
It is important to acquire the skills of a
knowledgeable, financially sound facilitating company.
At Jeld-Wen 1031. we believe the
Exchanger’s interests are best served and protected by a
facilitating company with multiple officers,
specifically designed to accommodate exchanges.
Individuals serving as Facilitators may jeopardize the
transaction in the event of personal, financial, health
related problems or accidental death. At American
Exchange Services the process of a successful exchange
is our purpose and goal but the protection of the
exchange funds is our number one priority.