Ten Rules For A Successful 1031 Exchange

The 1031 Exchange is a valuable tax deferral tool for the owners of investment real estate. A 1031 Exchange allows a taxpayer to sell an investment property and rather than paying capital gains taxes on the sale, use that money to purchase another investment property.  If the IRS rules are followed and the transaction is structured properly, a 1031 Exchange can be a useful wealth building strategy.

Certain rules must be followed in the sale and transfer of the property to insure that it qualifies as a tax deferred exchange:

1. An investor can sell his investment real estate property but must use the proceeds from the sale of the ‘Relinquished Property’ to purchase a ‘like – kind’ property. Both properties must have been held for use in a trade or business.
2. The Seller must enter into a written agreement with a Qualified Intermediary (QI). The QI acts as the principal in the sale of the Relinquished Property and the purchase of the Replacement Property.
3. The Qualified Intermediary receives the proceeds from the sale of the Relinquished Property, usually placing them in a segregated account. The Seller does not touch these funds.
4. The day the sale of the Relinquished Property closes, the 45 Day Identification Period begins. There are generally no extensions to this Identification Period.
5. Replacement Property or properties must be identified in writing to the Qualified Intermediary with complete legal descriptions or addresses. For the 3 Property Rule, three properties may be identified without regard to their fair market value, although it is wise to select a property of equal or greater value than the Relinquished Property. This process must be completed within the 45 Day Identification Period.
6. The 200% Rule means that more than three properties may be selected as long as the aggregate fair market value of these Replacement Properties does not exceed 200% of the aggregate fair market value of all the exchanged properties, as of the transfer date of the Relinquished Property.
7. The 95% Rule allows any number of Replacement Properties to be selected if the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate fair market value of all of the identified potential Replacement Properties.
8. The Replacement Property must be identified and the exchange must be completed within 180 days from the date that the Relinquished Property closed.
9. Title to the Replacement Property must be taken in the same manner that it was held in the Relinquished Property. For example, if Joe and Mary Smith sell their investment property and implement a 1031 exchange then Joe and Mary Smith must take title to the replacement property in the same manner.
10. “Boot” is taxable and can be avoided by selecting a Replacement Property that is of equal or greater value than the Relinquished Property. ‘Boot’, is money or the fair market value of ‘other property’ which is non-“like-kind”, such as personal property or a promissory note.

The IRS regulations for a 1031 Exchange are transparent and offer money saving benefits to tax paying investors. However, the transactions must be carefully structured and it is imperative that time deadlines (45 day/180 day) be met.

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This material is neither an offer to sell nor the solicitation to purchase any security. The information is for discussion and information purposes only. It is not intended to replace competent legal, tax or financial planning advice. The applicable tax codes apply to and relate to federal law only. Individual states may have their own additional tax codes Please contact the appropriate tax and legal professional in your state. This information is provided from sources believed to be reliable but should be used in conjunction with professional advice that is consistent with your personal situation.

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