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What does the term 1031 refer to?
1031 is the number assigned to the Internal Revenue Code Section
that provides for the tax deferred exchange of real and
personal property.
What does the term Starker refer to?
It refers to the landmark 1979 federal case entitled, Starker v. U.S., 602
F2d 1341 (9th Cir. 1979), wherein the court substantiated
the validity of the delayed exchange process. Prior to the
Starker case, the courts had never sanctioned an exchange
whereby the relinquished property was sold and, at a
later date, the replacement property was purchased.
What are "Safe Harbors"?
This term refers to the rules
established by the 1991 Treasury Regulations for tax
deferred exchanges which provide that – if followed – the
IRS will allow the exchange to qualify.
Why is the tax deferred exchange a popular financial
planning tool?
If done correctly, investors defer tax due
in connection with the sale of real or personal property,
enabling them to access their equity to consolidate, diversify,
leverage or relocate their investments.
Why use a Qualified Intermediary?
Use of a Qualified Intermediary is sanctioned as a safe harbor by the IRS.
What is like kind?
Real or personal property of the same
nature or quality is like kind. Generally, real property is
like kind to all other real property, except foreign real
property, as long as it is held for investment or the productive
use in a trade or business. Personal Property must
be either the same General Asset Class or Product Class.
How do I properly identify my replacement property?
Property is properly identified only if you unambiguously
described it in a written document signed by you and
hand delivered, mailed, telecopied, or otherwise sent to
the person obligated to transfer the replacement property to
you (i.e., the Qualified Intermediary or the seller of the
replacement property) or to any other person "involved
in the exchange" other than you or a person disqualified
under Treas. Reg. §1.1031(k)-1(k). Real property generally
is unambiguously described if it is described by a legal
description, street address, or distinguishable name (e.g.,
the Mayfair Apartment Building). If at the end of the
identification period – 45 days – you have identified more
properties than permitted by IRC §1031, it is treated as
if no replacement property was identified and the
exchange will be disallowed.
What are the 45 and 180 day deadlines?
Beginning with the close of the relinquished property, you have 45
days to identify the properties you intend to purchase
and 180 days (or the due date for your tax return –
whichever is earlier) to complete the acquisition of those
properties. In addition, the 45 day identification period
and the 180 day exchange period are calendar days. If
the 45th day or 180th day falls on a weekend or holiday,
the deadlines still apply. There are no extensions for
Saturdays, Sundays, or legal holidays.
Is there any way to get an extension on the 45 day or
180 day deadlines?
No extensions are allowed on the
45 day deadline. Your identification must be received,
signed, in writing, on or before midnight of the 45th
day. With respect to the exchange period, it ends on the
earlier of the 180th day or the due date (including
extensions) of your tax return for the taxable year in
which the transfer of the relinquished property occurs.
Thus, if the exchange period is cut short by the earlier
occurrence of your tax filing date, you may file for an
extension in order to get the full 180 day exchange period.
What is Boot?
Broadly defined, boot is considered:
1)"Cash boot" – money received (or not reinvested)
by you during an exchange. If you carry a note for the
buyer, the note is also considered cash boot.
2)"Mortgage boot" occurs when you pay off a loan on
the sale of the relinquished property but do not either
get a loan for equal or greater value when you buy the
replacement property or invest additional cash equal to
your debt relief. In other words, if you choose not to
get a loan on the replacement property, it is perfectly
acceptable to simply come up with the additional cash
required to purchase the replacement property.
3) Any type of replacement property received that is
not like kind.
If I own a property with another investor, can I
exchange my interest if he doesn't want to?
Yes. You would want to clearly allocate each investor's interest in
the property before you sell. The investor who wishes to
exchange may do so, and the other investor may receive
cash (taxable). It is, however, very important that the
investors be clear on their intentions before entering into
an exchange agreement with a Qualified Intermediary.
Once a relinquished property is closed where all
exchanging parties are under one exchange agreement,
the exchangers do not have an option of dividing
proceeds and buying separate replacement properties.
What is a partial tax exchange?
If the equity in your
investment property is $150,000 and you wanted to use
only $100,000 to purchase your replacement property
and take $50,000 out to buy a new car, you would have
a partially tax deferred exchange. The $50,000 cash you
took to purchase the car is considered taxable cash boot.
May I take out my basis and reinvest only the gain?
No. Both basis and gain must be reinvested to defer
taxes. The IRS does not allow you to allocate a portion
of the money as basis and a portion as gain. Any money
received by the Exchanger will be considered boot and
taxed at a capital gain rate.
What is the net value of the property?
Simply stated, the net value is your sales price less your closing costs.
The Exchanger is responsible for reinvesting both the
cash and the loan amount when they purchase the
replacement property. (See section on Boot.)
Can a carry-back note, drawn in my name, be
assigned to the Qualified Intermediary as part of
an exchange?
No. Once the note is received by you, it
will be taxable boot. Alternatively, to use the note as part
of the 1031 exchange, the note and deed of trust must
be drawn in the Qualified Intermediary's name.
How does the note become part of the exchange?
The note must be drawn in the name of the Qualified
Intermediary. During the 180 day exchange period,
you have several options in using the note as part of
the exchange:
(1) Sell the note to a buyer and liquidate it to cash that
is then added to the exchange proceeds and applied to
the purchase price of the replacement property;
(2) Obtain the agreement of the replacement property
seller to accept the note as part of the purchase price to
be paid for the replacement property;
(3) Accept only a short-term note (i.e., due in less than
6 months) that will be paid off in full prior to acquisition
of the replacement property. Payments received are
added to the exchange funds and used to purchase the
replacement property.
I own a piece of property that has my own primary
residence as well as a rental unit. Would it still qualify
for an exchange?
Yes, so long as you remain consistent
with your past tax returns. Consult with your tax advisor
to determine the percentage of the value of the property
you have attributed to investment. You may exchange
that portion of the value.
How long must I hold a property for investment
before I can move into it for my own residence?
The IRS has never established any rule for a required holding
period for investment property to qualify under IRC
§1031. If you are considering converting investment
property to a principal residence, we strongly recommend
that you consult with your tax advisor.
What does the term "disqualified party" refer to?
The Treasury Regulations provide that certain
persons/entities are disqualified from acting as a
Qualified Intermediary. Disqualified persons include
anyone who can be considered your agent, anyone who
is a related person as defined in the Code, or anyone
who is related, as defined by the Code, to your agent.
Your agents include anyone who has acted as your
employee, attorney, accountant, investment banker, real
estate agent or broker within the previous two years.
Can I exchange with a related party?
Yes, subject to certain restrictions – namely a two year holding requirement
– you may sell property to or swap property with a
related party. If you engage in an exchange with a related
person, you are entitled to non-recognition of gain only
if the replacement property is held by you for at least 2
years and the relinquished property is held by the related
person for at least 2 years after the date of the last transfer
in the exchange transaction. Related persons include
members of your family and descendants, corporations,
tax-exempt organizations and partnerships that are controlled
orowned by you. The grantor, fiduciary and beneficiary
of a trust are also considered related parties. It
is not advisable to buy property from a related party.
Do I have access to my money during the exchange?
During the exchange transaction, your exchange proceeds
are placed in an exchange trust account so that you do
not have actual or constructive receipt of the funds. If
you have not identified property, you may not receive
the exchange funds until after the expiration of the 45th
day. If, however, you identified property but you later
decide not to exchange, you may not access the funds
until the expiration of the 180 day exchange period.
(Some limited exceptions apply.)
What are exchange expenses?
Certain expenses incurred
in selling the property, which include, but are not limited
to, the real estate commission, exchange fees, legal fees
and transfer taxes, may be paid from the proceeds of the
sale of the relinquished property thereby reducing the
amount that must be invested in the replacement property.
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