1031 Exchange: Frequently Asked Questions (FAQs)Answers to questions about IRC Section 1031 Like-Kind Exchanges and Qualified Intermediaries. Have a question not covered here? Please call or email anytime.
Why should I choose ERG/EquipEx as the Qualified Intermediary (QI) to handle my 1031 Exchange?
1031s are all we do and we do them expertly! ERG/EquipEx is a dedicated QI that provides the most thorough and personable service in the industry. Our Certified Exchange Specialist® and other staff will spend as much time as needed for you and anyone else involved in your Exchange to feel completely comfortable with the process, at no additional cost. We meet or exceed all state and federal standards for client (Exchanger) protection, have substantial experience facilitating 1031 Exchanges for all types, locales and sizes of property, and our fees are highly competitive.
Do I need to find a Qualified Intermediary located in my home state or in the state(s) I’m relinquishing and acquiring property in?
No. A QI, an Exchanger and the Exchanger’s 1031 properties may reside anywhere without impacting the validity of a 1031 Exchange. Properties exchanged must either be domestic-for-domestic or foreign-for-foreign.
Why participate in a 1031 Exchange?
There are a variety of reasons why taxpayers tap into the benefits of Section 1031 and the Like-Kind Exchange:
• To achieve as much as 100% federal, and typically state, tax deferral • For tax-intelligent estate planning • To improve cash flows
• To diversify or consolidate geographically or among property types • To enhance reinvestment purchasing power
• To build and preserve wealth • To adjust to changing appreciation, income, active management or passive management needs
How are my interests and money protected?
While Qualified Intermediaries like EquipEx are not currently regulated at the federal level, certain states have passed legislation in recent years to better protect Exchangers’ interests. The State of Colorado, ERG/EquipEx’s home state, passed House Bill 1254 in 2009, which makes certain requirements of QIs residing in Colorado. EquipEx meets or exceeds all such requirements, including professional liability insurance coverage (aka E&O) at four times the state minimum and the establishment of a Qualified Escrow Account (QEA) to hold Exchangers’ proceeds. In addition, EquipEx carries a $1 million cyber fraud insurance policy and uses a unique QEA for each Exchanger, so that your 1031 Exchange proceeds are never co-mingled with another Exchanger’s. EquipEx also has a Certified Exchange Specialist® on staff, signifying extensive 1031 Exchange experience and a commitment to uphold the highest ethical standards.
How much taxable gain does it take for it to make sense to participate in a 1031 Exchange?
In general, if you’re selling property that will result in at least $15,000 in normal gains or $10,000 in capital gains, a 1031 Exchange is likely to make financial sense. We strongly recommend that you consult with your tax and/or legal professionals regarding your particular situation and objectives before entering into a 1031 Like-Kind Exchange.
What types of property qualify for a Section 1031 Like-Kind Exchange?
As of January 1, 2018 and due to the passing of the “GOP Tax Reform Bill” a.k.a. “Tax Cuts and Jobs Act of 2017”, Section 1031 of the Internal Revenue Code (IRC) is allowable for Exchanges of nearly all types of real estate. Such property must be held for use in a trade or business or for investment purposes. If the sale of your property will result in taxable gain, consider boosting your cash flow and return on investment with a 1031 Exchange!
What types of property do NOT qualify for a Section 1031 Like-Kind Exchange?
Disallowed properties since the inception of I.R.C. Section 1031 include:
• Inventory or stock in trade • Stocks, bonds, or notes • Other securities or debt • Partnership interests • Certificates of trust
The Tax Cuts and Jobs Act (TCJA) of 2017 eliminated non-real estate assets from Section 1031 eligibility, effective January 1, 2018.
Is the 1031 Exchange a “tax loophole”?
No, the 1031 Exchange is a legitimate part of the Internal Revenue Code, implemented to stimulate domestic reinvestment of proceeds from the sale of one or more properties into other, similar property(ies). When a taxpayer (Exchanger) sells business-use or investment property, typically using a Qualified Intermediary (QI) to facilitate the 1031 Exchange, income and capital gain taxes are deferred and cash flow preserved in accordance with Section 1031 of the Tax Code, provided that “like-kind”, or in some cases “like-use”, property is acquired.
If I’ve already sold or replaced property, or am in the process of doing so: can I still qualify for a 1031 Exchange?
The answer is: “it depends.” If ownership of the property has been transferred by title/deed, payment or use, it’s likely too late to participate in a 1031 Exchange for that property. However, if you haven’t finalized the sale and haven’t received or paid funds, you likely have time to open a 1031 Exchange for the transaction by engaging the services of a Qualified Intermediary. A Reverse 1031 Exchange might also be possible – this type of Exchange allows you to acquire one or more properties before you’ve relinquished your current property.
What does “like-kind” mean – how similar do my outgoing and incoming assets have to be to qualify for a 1031 Exchange?
In 1031 Exchange vernacular, “like-kind” is a broad term. Any real property interest located on U.S. soil is considered like-kind to another property as long as it’s “…held for productive use in a trade or business or for investment” and is located on U.S. soil. For example, an Exchanger can sell an apartment building in Alaska and purchase a vacant lot in Florida and/or two warehouses in Maine.
If I sell one property in a 1031 Exchange, can I acquire more than one replacement property with the proceeds?
Yes, you can sell any number of properties within a 1031 Exchange and purchase the same number or a different number of properties, with complete tax deferral, as long as your reinvestment total is equal to or greater than your net proceeds plus the amount of debt relieved. For example, you could sell a free-and-clear building for a net sale price of $500,000 and buy a building for $300,000 and a parcel of vacant land for $200,000, thereby achieving full tax-deferral. Any proceeds not reinvested, or debt relieved, will be considered taxable “boot” by the IRS at the conclusion of your 1031 Exchange, and taxed at the rates that would have been applicable without the Exchange.
How involved is the 1031 Exchange Process?
The typical 1031 Exchange, when managed properly by an experienced Qualified Intermediary (QI) such as ERG/EquipEx, adds minimal time and work for you, the Exchanger, and other parties involved. When completing your first “1031,” plan on an at least an hour or two to review and execute Exchange Agreement documents with the QI and an extra 30 minutes minimum for each sale and purchase relating to the Exchange. Related parties (the buyers and sellers you are transacting with, and possibly their agents) have only to receive written notification of your participation in the Exchange. Finally, you or your tax professional will complete an IRS form, usually Form 8824, which provides value and basis information on the properties exchanged. This form accompanies your federal tax return; time involved depends on the number of properties exchanged and accessibility to details (when purchased, price paid, depreciation taken, improvements made, etc.). Time and dollars invested are typically small in comparison to the financial benefits garnered!
What is the “nanosecond” rule?
The “nanosecond” rule is merely a collaborative opinion on the part of many tax and Section 1031 experts, which refers to how long an Exchanger needs to wait before entering into a cash-out refinance after they’ve closed on a replacement property. The logic behind this rule is that once an Exchanger owns the replacement property and refinances it, thereby incurring a repayment obligation, they are in the same position as anyone else owning property and refinancing it. Most experts caution that the Exchanger should not arrange refinancing while completing acquisition of the replacement property, nor have it pre-arranged prior to the acquisition. Best practice is to begin the cash out refinance process after completing the replacement property acquisition.
Is personal use of my relinquished or replacement property allowed? Or, is property eligible for Section 1031 treatment if I’ve had some personal use of it?
The IRS issued Rev. Proc. 2008-16 in March, 2008, which gave taxpayers (Exchangers) “Safe Harbor” guidance on what qualifies a dwelling unit as “held for productive use in a trade or business or for investment” under Section 1031. It states that the IRS will not challenge whether a dwelling unit qualifies for Section 1031 treatment if the following requirements are met:
• The relinquished dwelling unit (RQ) is owned by the Exchanger during the 24-month period ending on the day before the date of the Exchange,
• The replacement dwelling unit (RP) is owned by the Exchanger during the 24-month period beginning on the day after the date of the Exchange, and
• Within each of the first two 12-month periods immediately before and after the Exchange:
- The dwelling unit is rented to another person or persons at fair market rent for at least 14 days; and
- The amount of personal use (including under-market rental use or non-rental use granted by taxpayer) does not exceed the greater of 14 days or 10% of the days the dwelling unit is rented at fair market rent.
Example: if you rent the replacement property (RP) for 200 days within the first or second 12-month period following the completion of your 1031 Exchange, you would be allowed personal use of that property for as many as 20 days in that same 12-month period. After two years, you are free to have as much personal use as you like, keeping in mind that these rules would also apply when selling the property in the future, i.e. you would need to establish a new 24-month business or investment use period to obtain Section 1031 Safe Harbor eligibility.
Although a property would not receive the “safe harbor” protections, it may still be eligible for Section 1031 treatment even if the above requirements are not met. Considerations include whether or not the Exchanger has: 1) rented or attempted to rent the property to others; 2) deducted mortgage interest as a home mortgage expense or as investment interest expense; and 3) taken depreciation or other tax benefits associated with an investment property including deductions for maintenance expenses.
What’s different about a 1031 Exchange involving related parties?
Special rules and guidelines apply when a family member or related entity is involved in a 1031 Exchange. Section 1031(f), added to the Code in 1989, requires a minimum two-year hold of acquired properties by each of the related parties. Exceptions are limited to:
- Proof, should the IRS require it, that neither “the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.” Most exchanges involve tax deferral so it may prove impossible to make this case. Favorable IRS rulings under this exception have typically involved family members exchanging undivided interests in several properties in order to allow each to own a whole.
- A situation where the party selling to the related party participates in his or her own 1031 Exchange, whereby proceeds are reinvested, there is no cashing out and therefore no potential for tax abuse.
- The death of the Exchanger or of the related person.
The primary related party guideline is that it’s fine to relinquish property to a related party, but it’s not allowable to acquire replacement property from a related party unless this party participates in their own 1031 Exchange. Barring this condition, it’s likely that the IRS will invalidate the Exchange on grounds of “basis swapping” and tax avoidance, whether done intentionally or not.
Have a question not addressed here or a particular scenario to discuss?
Give us a call to ask a quick question or to schedule a Free, No Obligation 1031 Exchange Consultation. We’ll be happy to provide as much objective information about 1031 Exchanges, and the role of ERG/EquipEx as your Qualified Intermediary, as possible. You can reach us at (303) 579-5545 or by email at .
Located in metro Denver, Colorado, ERG/EquipEx is a Qualified Intermediary (QI) for Section 1031 Like-Kind Exchanges locally and across the U.S. As a responsible QI, ERG/EquipEx cannot and does not provide tax advice. Please consult with your tax professional regarding your particular situation and objectives before participating in a 1031 Like-Kind Exchange.