If you are considering a 1031 Exchange, we recommend that you inform all of the parties involved as quickly as possible. A simple phone call to your attorney and your closing company will do. You should also discuss this with the buyer or seller of the property. Work with your attorney to craft language in your Purchase and Sale Agreement that reflects your intention to sell or buy as a 1031 Exchange. There is no regulation regarding this. Just considered it as a common courtesy to everyone involved.

We suggest that you insert language similar to the following Suggested Earnest Money clause into your Purchase & Sale agreement so that all parties are aware that the transaction will be a delayed exchange, and there will be no lack of disclosure which may obstruct the transaction. (This is merely a suggestion, and is not required by the “1031″ regulations)

“A material part of this transaction is the successful completion of an I.R.S. Code Section 1031 deferred exchange. “Buyer/Seller” agrees to cooperate with the “Exchanger” (note: insert the full name of the party doing the exchange in place of the word “Exchanger”) in signing those documents necessary to complete the exchange, provided that “Buyer/Seller” shall incur no additional costs or liabilities in excess of those which would have occurred had this been an outright “purchase/sale,” and not an exchange.”

There is an ingenious tax strategy that permits you to take back boot in a 1031 exchange without paying tax on it now. Gain from the boot can be deferred into future tax years. It’s done by taking back a purchase money installment note from the “buyer” of the Relinquished Property to balance all or part of the equities. When structured correctly, the taxable gain in the note may be reported using the installment method of tax accounting.

One of the most frequently asked questions here at Realty Exchanges is “Can I take a note on the sale of my Relinquished Property and still qualify for a deferred exchange?

In a word, yes. Realty Exchangers, Inc., handles many of these transactions and knows the correct procedure that must be followed to assure §1031 treatment. The installment note and related documents are made out in the name of the QI. You have four choices on how to use it to buy replacement property:

1. You can use it to acquire Replacement Property by trading it to the “Seller ” for part of the consideration for purchase of new property. This does not trigger the unrecognized gain in the installment note.
2. You can instruct the QI to sell the note on the open market (you can negotiate this sale or have the QI do it as your agent) and add the amount realized to the exchange proceeds. This will give you all cash to negotiate your replacement purchase. It’s less desirable because of the discount you might have to give on the sale of the note. This does not trigger the unrecognized gain in the installment note.
3. A party related to you, the exchanger, such as a closely held corporation or relative can either purchase the installment note from your QI or provide financing so that your QI receives all cash at closing. You should consult with your tax advisor regarding structuring this type of transaction. This does not trigger the unrecognized gain in the installment note.
4. You can wait until the end of the exchange and receive the installment note back from QI. This will result in the note becoming “boot” and it will be taxable. However, at this point the installment sale rules under §453 kick in and you are permitted by election to use the installment method of tax accounting and only recognize capital gain as you collect principal payments each year. Interest on the installment note is always taxable at ordinary income rates. Your installment sale percentage for figuring gain will be 100%.

We get many questions for tax payers who are thinking of schemes to have the benefits of the 1031 Exchange but without actually selling their property to someone and buying another from someone else.

The intent of the 1031 exchange is that you have an actual continuation of your old property investment into your new replacement property. To qualify, you must follow the rules and requirements of Section 1031 of the Internal Revenue Code. Intent does not count. What you actually do is what determines if you qualify.

Exchange Requirements

Section 1031 requires an actual exchange of properties. If you simply sell your property and reinvest the money in another property, you will not qualify for exchange treatment, even though it is a simultaneous close.

The secret of a successful deferred exchange is avoiding receipt of money or other property during the transaction. If you receive the cash proceeds from the exchange of your property, you will not qualify for §1031 treatment. While this may sound easy to avoid, it’s not. You must overcome the doctrine of “ constructive” receipt. The general rules concerning actual and constructive receipt apply to determine if you are in actual or constructive receipt of money or other property before you actually receive like-kind Replacement Property.

You are in actual receipt of money or property at the time you actually receive the money or property. You are also treated as being in receipt if you receive the economic benefit of the money or property. You are in constructive receipt of money or property at the time the money or property is credited to your account, set apart for you, or otherwise made available to you so you may draw upon it at any time. Or if you can draw upon it if notice of intention to withdraw is given. In addition, actual or constructive receipt of money or property by your agent is actual or constructive receipt by you.

The deferred exchange Regulation provides a “safe harbor” that permits you to sell your Relinquished Property and acquire Replacement Property and avoid constructive receipt. This safe harbor is your written contractual agreement with a Qualified Intermediary.

Here’s an except from our FREE 1031 Exchange Procedure Manual. Get yours today!

The 1031 Exchange treatment of capital gains is one of the best real estate investor vehicles for preserving and building real estate wealth: This provision of the Internal Revenue Code allows property owners to exchange their property for other like-kind property without recognition of capital gains. It makes possible to transfer the financial gain that is realized from the sale of a property into another property without federal capital gains tax at the time of the sale.

The Deferred Exchange is Different From a Swap

Exchanging properties is not new. The “your property” for “my property” type of direct exchange (i.e., a swap) has been in practice for a long time – it’s called a two-party exchange. The difficulty is rarely will you find two owners who each want the other’s property. Normally, the other owner wants to sell. This presents a problem if you want to dispose of property to finance the acquisition of new property and avoid taxable gains that would substantially reduce your equity.

The three-way or multi-party exchange was a tax-inspired technique designed to solve the dilemma of a two-way swap. However, these exchanges were fraught with danger. When one or more of the parties would not cooperate with the exchange, or one of the legs failed, the exchange failed. Multi-party exchanges, at best, were difficult and risky. And trying to sell your old property before closing on the purchase of the new property almost impossible. This presents a problem if you desire to dispose of property to finance the acquisition of new property but want to avoid selling your property in a taxable event. A sale would produce taxable gains and could substantially reduce your after-tax proceeds. If you could exchange your property tax-free for the desired property, you could benefit from the fair market value of your property undiluted by income taxes on the sale. In other words, you can use your entire equity before taxes to purchase the Replacement Property.

To solve the dilemma, on April 25, 1991, IRS issued the long-promised deferred exchange regulation-Reg 1.1031(k)-1. It permits you to “sell” your Relinquished Property now and use the proceeds to buy the Replacement Property later. As long as it’s done following the rules and using the services of a Qualified Intermediary, you get tax deferred §1031 treatment.

New Tax Terms: A deferred exchange is an exchange in which you transfer qualified property called the “ Relinquished Property” and subsequently receive qualified property as consideration. The property received is called “ Replacement Property“.

The Deferred Exchange Regulation is a taxpayer’s dream come true. It works without the buyer of your Relinquished Property or the seller of the Replacement Property getting involved in your exchange. The Reg’s secret weapon was the creating of a legal entity called the Qualified Intermediary or QI. This new entity is permitted to serve as your agent and do all the exchange stuff for you without getting you involved in a taxable sale of your old property. By using a Qualified Intermediary to handle your exchange transaction, you can now turn the sale of your property, and subsequent purchase of another “like-kind” property, into a §1031 exchange.

This regulation explaining how to put together the §1031 deferred real estate exchange is a powerful tool and strategy for selling appreciated business, farms, land, and investment real estate without recognition of gain for income tax purposes. It spells everything out-step by step. Just follow the rules and you can sell your appreciated property, use the cash proceeds to buy your Replacement Property and qualify for the full benefits of non-recognition of gain under §1031. The regulation has the weight of law and all parties must follow it-even the IRS.

One of the outstanding features of the deferred exchange regulation is it establishes and defines the Qualified Intermediary (QI) as your vehicle to qualify for the safe harbor procedures you must follow to get non-recognition of gain treatment on your deferred exchange.

As you read about 1031 Exchange, you begin thinking about your own properties and wondering if they qualify for 1031 tax capital gains tax deferral. If your goal is to 1031 Exchange your property, you should make sure you understand the rules. For the most part, they are easy to follow, easy to understand, and easy to access; once you know where to look for them!

Where can I find information about 1031 Exchange?

• The IRS. All information about 1031 Exchange springs from one single source, the Internal Revenue Code Title 26, Section 1031, which can be viewed and read for free on Cornell University’s web site at http://www.law.cornell.edu/uscode/26/usc_sec_26_00001031—-000-.html. Since this was written by lawyers and law makers, the language may be difficult to understand to the average lay person.
• Free 1031 Exchange Procedure Manual. The next best location where you can find 1031 Exchange Information is Realty Exchanger’s FREE 1031 Exchange Procedure Maual. On-line since 1995 and revised yearly, this 15 page manual is the best, quickest and most efficient way to get clear, concise and easy to understand information about IRS Section 1031 Exchanges. It includes all the information you need to know to successfully conduct a 1031 Exchange and reap its tax deferring benefits.
• Free 1031 Exchange Information Center. If you require further reading, Realty Exchangers’ 1031 Free Exchange Information Center is a complete knowledge base full of hundreds of articles written by experts in the 1031 Exchange field.
• Free 1031 Exchange Information Blogs. If you are looking for current and quality information about IRS 1031 Exchange, be sure to check out one of the 5 blogs maintained by Realty Exchangers.
  • 1031 Exchange FAQ Blog — hundreds and hundreds of Frequently Asked 1031 Exchange questions asked by taxpayers seeking information about 1031 Exchange. New questions are added daily and every question is readily indexed and searchable.
  • 1031 Exchange is Easy Blog — Top 1031 Exchange DIY Tips and Informative articles explaining how to make your 1031 Exchange easier and more efficient.
  • 1031 Exchange Procedures — Focusing on all of the 1031 Exchange procedures and how they work with your 1031 Exchange.
  • 1031 Exchange Information Blog — Focusing on all of the new 1031 Exchange information as it becomes available.
  • 1031 Exchange Knowledge Base Blog — An extension of Realty Exchangers 1031 Exchange Knowledge Base, this blog focuses on updates and new articles as they are published.

Where can I find a local 1031 Exchange Realtor?

Getting help is one of the most important decisions you will make when it comes to your 1031 Exchange. You need to choose a team that will react and anticipate your needs. Having a seasoned Realtor on your side is a great start. But how do you find one that knows and understands 1031 Exchange? Not all Realtors are versed equally in like-kind exchanges. A great place to start your search is to look at the 1031 Exchange Professionals Directory.Here you will find pros in every major city in every state who have successfully conducted a 1031 Exchange. These Realtors are ready to help and begin your 1031 Exchange when you are.

Where can I find 1031 Exchange property?

Soon as you sell your 1031 Exchange property the clock begins on your search for replacements. If you are lucky enough to have already located a suitable replacement property, good for you! But many 1031 Exchangers must begin the arduous search of finding the best 1031 Exchange Property at the best price. The best place to look? Try out the 1031 Exchanger’s Clearinghouse, a national search engine for locating 1031 Exchange property. This FREE service is available to anyone in need of a replacement property. Realtors should know about it and list their property, it’s free and easy and effective!

Where can I do a 1031 Exchange?

The rules governing 1031 Exchange are very clear when it comes to where you may purchase 1031 Exchange property. Qualifying 1031 Exchange property must be located within the 50 US States OR the US Virgin Islands. Any property outside these boundaries, including the US Territories, is considered foreign soil. Foreign soil is NOT qualified for 1031 Exchange, even if the property you sold was in the US, you cannot purchase property outside the US and have it quality for 1031 Exchange.

Where do I report my 1031 exchange?

When you have completed your 1031 Exchange, you need to file it with the IRS using Form 8824. We recommend discussing this with your CPA or tax advisor to insure the form is completed correctly.

Where do I go from here?

Getting quality information about 1031 Exchange (if you are planning on doing one) is a must!  A quick visit to RealtyExchangers.com is a great place to start!

The Who, What, Where, When, Why and How of a 1031 Exchange can be found here!

1031 Exchange – Who?
1031 Exchange – What?
1031 Exchange – Where?
1031 Exchange – When?
1031 Exchange – Why?
1031 Exchange – How?

When your 1031 Exchange property becomes a 1033 property due to involuntary conversion, you must be aware that the time to pick a replacement property is limited, just as it is with a standard 1031 Exchange.

To avoid reporting your gain from a condemnation, you must buy qualified replacement property within a certain period of time. This is called the replacement time period and it ends 2 years after the close of the first year in which any part of your gain on the conversion was realized.

The replacement time period starts on the earlier of these two dates:

1. The day you dispose of the condemned property, or
2. The first day the threat or imminence of condemnation started.

Special Rule of Certain Real Estate

For real estate used in a trade or business or held for investment, the replacement time period is extended one year. It ends three years after the close of the first tax year in which any part of the gain on the condemnation is realized. Dealer property does not qualify for this extra year.

The replacement property must exist before your replacement time period runs out. In Rev. Rul. 56-543, the IRS ruled an advance payment made to a contractor for construction of replacement property, where the property did not exist prior to expiration of the replacement period, was not a purchase of replacement property.

Extensions of Replacement Time Period

It’s possible to get an extension of time if you apply before the end of your replacement time period. However, you must show reasonable cause for not making the replacement during the regular period. The high market value or scarcity of replacement property is not a sufficient reason for granting an extension. If you are constructing the replacement property, and clearly show the replacement cannot be made within the replacement time period, you can get an extension.

Replace Property Before Condemnation

It’s OK to acquire your replacement property before the actual condemnation takes place. To qualify, you must do it after there is a threat of condemnation and you must hold it at the time of the condemnation. Property acquired before there is a threat of condemnation does not qualify as replacement property.

Involuntary Conversion of Your Home

You may elect to treat the gain on the conversion of your primary residence as an involuntary conversion or as a voluntary sale.

If you qualify for the Section 121 exclusion, you can elect to exclude all the gain up to $500,000 (married filing jointly or $250,000 single) no matter which treatment you choose.

To avoid recognition of all the gain, the cost of your replacement property must equal or be more than your net proceeds for the condemned property. Your net proceeds are the total proceeds reduced by your expenses of securing the award and any special assessments levied against remaining property resulting from the installation of an improvement.

If the cost is less, the difference is recognized as gain. Look at it this way: If the condemnation or other award received is more than the cost of the replacement property, the excess is treated just like boot received in a Section 1031 like-kind exchange. It’s taxable.

Caution: Any payments made to third parties on your behalf out of your award are included in your net proceeds.

It is not necessary to trace the proceeds of a conversion to the replacement assets. Nor is it necessary to deposit the proceeds of the conversion in a separate trust or escrow account or otherwise segregate the proceeds.

The cost of replacement property is figured in the regular way. It includes cash paid and mortgages given.

Making the Election

You elect nonrecognition of gain by not reporting a recognized gain on your tax return for the year the conversion took place. You must report the details of the conversion including a complete description of the property, the amount of your gain and how you figured it, the kind of conversion (fire, etc.), and a statement of your decision to replace under Section 1033. Failure to report the gain in the year of conversion is treated as an election of nonrecognition treatment under Section 1033.

If you report the gain in the year of conversion, but later qualify for nonrecognition, you may file an amended return. The claim must be filed before the end of your replacement time period.

If you don’t meet the requirements of Section 1033, you must file an amended return for the year of the conversion and refigure your tax.

You must report all details of the replacement property on your tax return for the year of replacement.

If you die after the conversion, but before the replacement, the IRS and Courts differ on qualifying. The IRS says you cannot qualify if the replacement of the converted property is made by your executor or testamentary trust who succeed to the ownership of the conversion proceeds. According to the IRS, Section 1033 nonrecognition benefits are limited to the individual taxpayer who held the property that was converted. However, the Third and Fourth Circuits have held your estate can qualify.

Whenever you in involved in a 1031 Exchange and have depreciable real estate and the total amount of your accumulated depreciation deducted is less than the amount allowable, the adjusted basis of the property must be adjusted for the unclaimed amount.

Here is the rule and what you should do!

When reporting the sale or exchange of depreciable real estate, the amount of depreciation allowed or allowable must be used to reduce basis in figuring gain or loss.

Let’s say for example, you were to sell a rental property but you never claimed depreciation. The amount allowable would have been $97,000. Since the amount allowable is more than the amount allowed (zero), you must reduce the basis of the rental property by $97,000 in figuring gain or loss on the sale. In a 1031 Exchange situation, this will reduce your substituted basis in the Replacement Property by $97,000.

Sometimes in a 1031 Exchange you may find it necessary to pay boot in a form other than cash. For example, you may give up precious stones to complete the exchange agreement. In these cases, caution is the byword—you are selling the boot.

This is so important, it needs repeating: Any boot you give (payment in part consideration of the Replacement Property) is treated as a straight sale of the boot. The tax-free provisions of §1031 do not apply to boot you transfer in the exchange. If you give money, no gain or loss to you is recognized on the money you give. However, if you give boot in property other than money, a gain or loss will be recognized. The transaction is treated as a sale of the unlike property and the regular gain and loss tax rules apply.

The gain or loss is the difference between your adjusted basis in the property and your amount realized. The fair market value is considered to be your amount realized. For example, as part of an exchange you give unlike property with a cost of $1,000. The fair market value of the property at the time of the exchange is $1,500. You will recognize a $500 gain.

If the personal property was business property (§1245), the gain would be treated as ordinary income to the extent of depreciation taken, and might be taxed as ordinary income.

If the sale of the personal property had resulted in a loss, the loss would be deductible as an ordinary loss since the nonrecognition of gain or loss provision of §1031 does not apply to unlike property.

There is a huge difference between intending to exchange and actually exchanging properties.

A great way to learn how to structure a successful 1031 exchange is experience and more experience. One way to get it is to read about how other people did it and what they did right—and wrong. The information in tax cases is powerful input. What did the taxpayer do right? Or what went wrong. Based on this input, we can ask ourselves this question? How can we arrange our transaction to make it successful?

Section 1031 requires an actual exchange of the properties. If you sell your property and reinvest the proceeds in the Replacement Property, you do not qualify for §1031 treatment.

The receipt of cash instead of qualified property can transform what was intended to be an exchange into a sale and purchase. However, in some cases, a transaction that took the form of an exchange did not fail to qualify for nonrecognition merely because the “seller” was obligated to transfer his property for cash but, prior to the closing, exercised an option to accept like-kind property instead of cash.

Sometimes attempts at three-corner exchanges do not qualify for nonrecognition of gain under §1031.

Caution: You will not get §1031 treatment merely if you intend to exchange—you must actually exchange your property. Example  court ruling

“An actual exchange is nevertheless essential for nonrecognition under Section 1031. The taxpayer who sells property must recognize gain or loss, even if he immediately reinvests the proceeds of the sale in like-kind property. * * * * Moreover, the requirements of an integrated plan of exchange demands more than the mere unilateral intent of petitioners. Petitioners presented no evidence of the intent, or even the knowledge, of the . . . other parties . . . regarding a plan of exchange. In any event, mere intent to effect an exchange is insufficient to bring the transactions within the parameters of Section 1031. * * * * We recognize that, had the parties structured the transactions differently, petitioners could have obtained the benefits of Section 1031.”