10 Important 1031 Exchange Rules
Posted By GUEST BLOGGER 03/09/2017 | 06:45PM | 0

A 1031 exchange, sometimes referred to as a “like-kind” exchange, can be a great option for those looking to sell and buy investment or business property.  A 1031 exchange allows an individual to legally defer paying taxes on capital gains by selling a property and investing that money directly into another property.  It’s important to note that a 1031 exchange is not a tax-free exchange, but rather it defers taxes while the individual is in possession of the exchange property.  The individual must pay taxes on the profit when he or she sells an exchange property for cash.

Here are ten important rules to keep in mind when doing a 1031 exchange:

Rule #1: Only “like-kind” property can be exchanged.  Luckily, the definition for “like-kind” is very general.  For example, an individual can exchange an office building in San Francisco for a condominium in Miami.  However, an individual cannot exchange an apartment building for a yacht.  The quality of the property is not a factor in the exchange.

Rule #2:  Domestic property cannot be exchanged for foreign property and visa-versa. Foreign and domestic property are not considered to be “like-kind”.  In other words, it’s perfectly acceptable to exchange an office building in Utah for an office building in Connecticut.  It’s also perfectly acceptable to exchange an office building in Mexico City for an office building in Toronto.  However, it is not permitted to exchange an office building in Connecticut for an office building in Mexico City. 

Rule #3: Only business and investment properties qualify for a 1031 exchange; personal property does not qualify.

Rule #4: The value and equity of the new property must be of equal or greater value than the property that was sold in order to qualify for 100% of the tax deferment.  In other words, all of the profit from the sale of the first property must be used to buy the second property.  It’s completely legal to trade for a property that is of a lesser value than the old property, but any profit will be taxed.

Rule #5: The individual who sells the first property must be the individual who buys the second property.

Rule #6: The person exchanging the property has 45 days from the closing day of the sold property to submit a list of up to three potential exchange properties.  The list must include the addresses or legal descriptions of the potential properties and the individual must intend to close on at least one of the properties.  The individual also has the option to list more than three properties, but the total value of all listed properties must not exceed 200% of the market value of the sold property.  If an individual needs to list several properties without restrictions, he or she may list more, but the individual must acquire and close on 95% of the identified value.

Rule #7: The individual has 180 days from the closing date of the sold property to purchase the new property.  There is an exception if the property owner extends his or her tax return.

Rule #8: The debt on the new property must be greater than or equal to the debt on the sold property.

Rule #9: Property that is bought with the intent to sell is excluded from 1031 exchanges.  For example, properties that are bought as “fixer-uppers” and then sold do not qualify for a 1031 exchange.  The intention must be business or investment.

Rule #10: Be careful about when to exchange cash and other proceeds.  Receiving cash (or money in the form of a check or deposit) before the exchange is legally complete can disqualify the exchange completely.  As per the IRS, you may not be your own facilitator.  Additionally, any real estate agent or broker, accountant, investment broker or banker, attorney, or employee that has worked with you in the past 2 years cannot act as your facilitator.

It is highly recommended that you hire a trusted qualified intermediary (QI) to help facilitate the transaction, especially if it is your first time doing a 1031 exchange. 

As always, trust your instincts and never continue with any deal that makes you uncomfortable.  And lastly, enjoy your new property!

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