A 1031 tax-deferred exchange can be a great tool for investors to defer taxes, but it’s important to follow the rules closely. Here are ten key points to keep in mind when considering this type of exchange.
1. Eligible Properties for §1031 Exchanges
A §1031 exchange applies only to investment properties. This includes land, commercial properties, or residential properties that are rented out. Personal residences or vacation homes do not qualify.
2. The Role of a Qualified Intermediary (QI)
To complete a §1031 exchange, you must use a Qualified Intermediary (QI). The QI acts as the “safe harbor” for your funds during the exchange process.
3. Spend Equal to Your Sale Price
In order to achieve 100% tax deferral, you need to spend an amount equal to or greater than the sale price of your relinquished property, minus customary closing costs. Any amount below this will be subject to taxes on the gain.
4. Understanding Like-Kind Properties
The IRS defines “like-kind” simply as anything held for investment purposes. This means you can buy or sell land, residential, or commercial properties, and they will all qualify as like-kind. You can also sell one property and buy multiple in return.
5. Strict Timeframes for Identification and Closing
The timeframes in a 1031 exchange are fixed and cannot be extended. You have 45 days from the sale’s closing date to identify the replacement property and 180 days to close on it. Keep in mind that the 45 days are part of the 180-day period.
6. Avoid Giving Buyer Credits
If you give buyer credits, these could be considered unallowable expenses under IRS rules. If audited, such credits may be classified as Boot (taxable cash). To avoid this, consider lowering the sales price instead of offering credits to the buyer.
7. Access to Funds Under 1031(g)(6) of the IRC
Once you identify a replacement property and pass the 45-day mark, you won’t have access to your funds if you don’t close on that property. Your funds will be locked for the full 180 days. This is why it’s crucial to work with a QI who can clearly explain these restrictions.
8. Restrictions on Family Transactions
If you’re buying from or selling to a family member (parents, children, siblings), there’s a two-year hold rule under related party guidelines. Both parties must hold the properties for at least two years, or the IRS could disqualify your exchange in an audit.
9. Be Cautious When Choosing an Accommodator
The exchange industry is not regulated, meaning anyone can claim to be an Accommodator. This lack of regulation is risky, so choose a nationwide company with financial stability to protect your funds.
10. Timing of the Exchange Agreement with a QI
Most importantly, you must be in an exchange agreement with a QI before closing on your relinquished property. If the agreement is not in place before the sale, you cannot defer any gains when you purchase your replacement property.
Sheila Long
Regional Sales Executive
Old Republic Exchange Company
C: 480.341.2032
T: 480.443.6830 -AZ
E: SheilaL@oldrepublicexchange.com
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