Frequently Asked Questions
The term refers to a tax-deferred exchange that allows for the disposal of an asset and the acquisition of another similar asset without generating a tax liability from the sale of the first asset.
The definition of an accredited investor can be found in Rule 501 of Regulation D. Click here to read the full rule.
Any real estate held for investment or use in a trade or business. This means all types of real estate qualify, whether developed property such as a rental house, apartment building, office building, shopping center, and the like, and undeveloped property, such as land, a farm or ranch. Effective January 1, 2018, personal property does not qualify for exchange treatment under Section 1031.
There are many property types that can be considered like-kind to each other, and they may include, but are not limited to:
· Healthcare related buildings
· Multifamily communities
· Office buildings
· Retail properties
· Interests in a DST
· Vacant land
· Development rights
· Industrial properties
· and more
Your principal residence and personal-use property do not qualify for Section 1031. There is a special tax provision under Section 121 that provides forgiveness (exclusion) of gain on sale of a principal residence but, effective January 1, 2018, the amount of gain forgiven is limited to $250,000 for a single taxpayer and $500,000 for a joint return. In highly appreciated areas, this may not be sufficient.
An Exchange Agreement with an accommodator or qualified intermediary (QI) should be signed before closing. The taxpayer has right up to the moment of closing to convert a “sale” into an exchange.
Yes; this is required to qualify for a safe harbor under the regulations.
No; inexpensive – the basic fee is only $750 to $1,000 for a simple exchange.
The “owner” for tax purposes signs the exchange agreement. Typically, the person or entity “on title” is the taxpayer who signs the exchange agreement.
Be careful with tax partnerships, LLCs and partnerships that have a tax identity number and file a partnership tax return; the entity (LLC or partnership) is the taxpayer and not members of the LLC or partners.
The sole exception is a single member limited liability company or SMLLC; that is a disregarded entity for tax purposes. In the case of a SMLLC, either the entity or the sole (100%) owner of the entity can be the taxpayer for purposes of the exchange.
The tax basis in your relinquished property carries over to the replacement property. Section 1031 defers the gain that otherwise would be recognized; Section 1031 does not forgive the gain. But you may exchange over and over and over again, creating almost perpetual deferral during your lifetime.
Many taxpayers use Section 1031 to build family wealth in real estate during their lifetime. When the taxpayer dies, the heirs get a “stepped up” basis to fair market value. That means the heirs can sell without having taxable gain.
So, while 1031 defers the taxable gain, the gain can be deferred for a life time and may be forgiven on death. This is whimsically called “swap until you drop”.
If you elect not to exchange, all the proceeds are returned to you. If you complete a partial exchange, all excess proceeds are returned to you. Any funds returned to you will be taxable. Note: depreciation deductions are recaptured (taxed) at a higher rate -- 25% plus 3.8% in some cases, plus state income taxes.
Yes; debt on the relinquished property must be offset by debt on the replacement property.
Yes; you may cash out some proceeds on a taxable basis and exchange the balance under Section 1031. Be aware that depreciation deductions are recaptured (taxed) at a higher rate -- 25% plus 3.8% in some cases, plus state income taxes.
Note: Once funds go to the QI, there may be a delay in the receipt of funds being cashed out. Therefore, if you want to cash out, it is best to receive the proceeds at the closing of the relinquished property.
If you want to reduce your debt and de-leverage the replacement property, you may bring cash from another source to closing and use the new cash to buy additional real estate. The new cash must be from another source, not cash from the relinquished property.
Let’s say you have a mortgage of $50 on the relinquished property and do not want debt on your replacement property. You may bring $50 from another source and use the $50 to acquire additional replacement property; the new cash will offset the old debt.
You can “trade up” by buying a larger replacement property. This can be done with debt or cash from another source and the debt may be non-recourse, where you are not personally liable. The trade-up amount will provide new tax basis which generates new depreciation deductions and expense deductions from property operations (for example - taxes, insurance, maintenance and repairs; this varies depending on asset class). New depreciation and operating expense deductions will reduce (shelter) the taxable income (rent) from the property.
Yes; use of a cost segregation study will permit you to accelerate (speed up) depreciation deductions. This can help shelter otherwise taxable rent from the replacement property.
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