1031 Tax Deferred Exchanges for Real Estate

Are you thinking of selling your property and purchasing new real estate and want to avoid paying capital gains on the sale? If so, an IRS 1031 Tax Deferred Exchange may be for you. On real property, with some exceptions, you may defer the recognition of capital losses or capital gains due at time of sale, under Section 1031 of the Internal Revenue Code of the United States. This allows you to defer capital gains taxes that otherwise would be due. You do not have to exchange with the owner of the property you want to purchase. You can sell to one buyer and buy from another owner.

Real property, and some other types of property that are held for the productive use in a trade or business or for investment generally qualify for 1031 tax deferred treatment. Property like stocks, bonds and other types do not qualify. Property is exchanged rather than bought and sold. Exchanged properties must be of “like kind”. In other words, it must be in the same character and nature but are not required to be same quality. This “like-kind” is fairly broad for “Real” property and fairly narrow for a business’s personal property. There are many options when exchanging Real Property. You can exchange a ranch for commercial building downtown or a rental home for a farm. Properties being exchanged through a 1031 in the United States must be exchanged for other property in the United States.

A common misunderstanding about 1031 exchanges is how the exchange works. The seller does not have to directly exchange with a property that their buyer owns. You can sell to a buyer for cash and then purchase a property from a different owner. But there are rules and timelines that have to be met to complete a Tax Deferred 1031 exchange.

Several items need to be considered in a 1031 tax deferred exchange.

1. What is your basis and how do you have title?

You only pay or defer tax on the capital gains which is the difference between your basis and your purchase price. Is a 1031 right for you? Do you own it with other owners and do they want to do a 1031 as well? Ownership has to be the same from the relinquished property to the replacement property.

2. Do you have debt on your relinquished property?

If so, you must take on an equal or greater amount of debt in your replacement property. If you do not, you may have ‘boot’ which is taxable.

3. 1031 exchange on a portion

You can do a 1031 exchange on a portion of your relinquished property, but there is the issue of ‘boot’ that is taxable should you choose to do this.

4. Tax Implications

When there is ‘boot,’ what tax implication do you have?

5. what will your exchange look like?

Will you be buying multiple properties or selling multiple properties and how does this work within the 1031 exchange process?

General guidelines and advice for a successful Tax Deferred 1031 Exchange.

Sell a property for use in a trade, business, or for investment.

Sell a property that is held for the productive use in a trade or business or for investment (personal residences or second homes do not qualify). This is called the Relinquished property.

Purchase a property that will be held for the productive use in a trade or business or for investment.

This is called the Replacement Property. The replacement property must be of equal or greater value of the relinquished property and all proceeds of the relinquished property must be used to acquire the replacement property.

Identify the Replacement Property

Identify the Replacement Property within 45 days of the closing date of the Relinquished property and close on the replacement property within 180 days of the same date. The two properties do not have to be simultaneous transactions.

Use a qualified Intermediary

Must use a qualified Intermediary that will be named as principal in the sale of your relinquished property and the subsequent purchase of your replacement property. When the relinquished property closes, the title company sends the proceeds to the qualified intermediary. The qualified intermediary holds the funds until it’s time for the transaction of the replacement property to close.

The qualified intermediary after closing the replacement property delivers the property to the buyer so the taxpayer does not have constructive receipt of the funds from the property they relinquished.

Involve your CPA in the process.

Your CPA has information that will be needed to decide if a 1031 exchange or a partial 1031 exchange is best suited to you.

Use a real estate broker that is experienced in the process of Tax Deferred 1031 Exchanges.

Using an inexperienced broker could result in an incomplete 1031 exchange or at minimum make the process less smooth.

Important items to note that can disqualify a Tax Deferred Exchange.

  • Incorrect or missing language in the purchase and sale agreement.
  • Not using a qualified intermediary.
  • Not meeting timelines.
  • If the seller receives proceeds or has control of the proceeds of the sale of the property that is being sold or relinquished, the exchange will be disqualified to the extent of the amount of the proceeds that are received by the seller. Putting a qualified intermediary in place prior to closing is done to help ensure the seller does not receive or have access to funds after the closing of the property being sold and before the property being purchased is purchased.
  • Purchasing property that is not considered “like-kind” or is your personal residence.

Tax Deferred 1031 Exchanges can be a great advantage for the seller wanting to expand, diversify, or downsize. They can be complicated, but with the right help the process can be made smooth. Make sure you get competent tax advice when doing an exchange so you know all the rules and regulations as well as the benefits and consequences of such a transaction, specific to your circumstances, situation and property. Your experienced Real Estate Broker, your CPA and a 1031 exchange company are all good resources and all should be involved.

The 1031 Exchange Real Estate Firm You Can Trust

Knipe Land Company is one of these real estate firms that is well versed in Tax Deferred 1031 Exchanges and can help make it as smooth as possible for you. Many land owners including farmers and ranchers often consider the benefits of a 1031 exchange when they are ready to sell their land. There are other types of sales that may better fit your needs, such as a “structured sale.” This is a special type of installment sale pursuant to the Internal Revenue Code. Installment sales permit sellers to defer recognition of gains on the sale of a business or real estate to the tax year in which the related sale proceeds are received. Certified Land Brokers and Certified Land Agents are trained and experienced in helping buyers and sellers complete 1031 Exchanges.