Real Property. Only real property can be used for tax deferred treatment.
The Purpose. The exchangers sold and replacement property must be for investment purposes. Property held for or bought as principal home or vacation home will not qualify.
Like Kind. Generally this means that property exchanged must be real estate. So the property acquired as the result of an exchange must be real estate.
The Exchange. IRC §1031 requires an exchange take place. One property must be exchanged for another. The exchange separates a 1031 exchange (and its tax deferred nature) from a taxable sale and subsequent purchase. Using a qualified intermediary ensures that a tax deferred exchange meets the requirements of IRC §1031.

From the day of closing on the relinquished property, the exchanger has 45 days to identify potential replacement properties and a total of 180 days from closing to acquire the replacement property.

From the day of closing on the relinquished property, the exchanger has 45 days to identify potential replacement properties and a total of 180 days from closing to acquire the replacement property.

Many types of businesses, real estate investors, construction companies, trucking, equipment leasing industries, farmers, and much more make use of 1031 exchanges. It is one of the few incentives available to and used by taxpayers of all sorts. And exchanges involve properties of all sizes and value.
Qualified Intermediaries (QI) facilitate non-simultaneous tax-deferred exchanges of investment and business use properties for taxpayers of all sizes, from individuals to high dollar taxpayers and from small businesses to large.

An unrelated third party that is used to facilitate the 1031 exchange transaction.

Identification rules in a 1031 exchange include: The 45-day requirement to designate a replacement property, the incidental property rule, the 3-property rule, the 95% rule, the 200% rule.

The number of days a taxpayer has to identify replacement property from the closing date of the relinquished property. Exchange rules state: “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.” The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange (qualified intermediary or QI)

The exchanger may identify three or fewer replacement properties to replace the relinquished property, as part of a forward exchange. This is the most common identification rule utilized.

The exchanger may identify any number of replacement properties as long as the exchanger receives at least 95% of the value of all properties identified. Note: This rule is not used very often.

The exchanger may identify any number of replacement properties; however, the total value of those properties identified cannot not exceed 200% of the value of Exchanger’s relinquished property.

Boot is property that is received in an exchange but is not “like-kind” as to other property acquired in an exchange transaction. Boot is the “fair market value” of the non-qualified property received in an exchange. An exchanger who receives boot in an exchange generally recognizes gain to the extent of the value of the boot received and pays tax on it. Boot will not negate a 1031 exchange.

Boot: Any non like-kind property received by Exchanger during the 1031 exchange.
Cash boot: Any cash, note or seller carry back received (or not reinvested) by Exchanger during an exchange period.

Mortgage Boot: Results when an exchanger is discharged of a debt obligation with the transfer of the relinquished property and that debt is not completely offset. For example, if your replacement property’s mortgage is $120,000 and your relinquished property’s mortgage is $130,000, then you will have $10,000 in mortgage boot. The IRS taxes boot at a taxpayer’s regular tax rates, and taxpayers report it on line 15 of Form 8824.

Regulations provide that any party to the exchange can be the necessary recipient of the notice. So, for example if the contract with the seller of the new property contains a reference in the contract stating that this is the replacement property for the buyer’s exchange, that would be sufficient.

However, you can also give notice to your qualified intermediary (QI) as part of the process.

There is no requirement under the regulations that the counter party needs to sign receipt of the notice of assignment. The counter party needs to receive the notice of the assignment. Receipt for it may be a courtesy but it does not harm the exchange if they won’t sign.

The primary purpose of a settlement statement on a commercial transaction is to let the buyer and seller see how the amount they have to pay, or the amount received was calculated. As a legal matter it is not required by any exchange rules. However, in different jurisdictions settlement agents have a practice of refereeing the (QI) and/or having them sign the settlement statement.

Yes, the 1031 exchange rules don’t start until the time the relinquished property is closed on. At that time neither the taxpayer nor his/her agent should be holding onto exchange funds, they should be with the qualified intermediary (QI).

During the 1031 exchange, if the exchanger actually or constructively receives the funds, the exchange loses its tax deferred nature. The exchange funds must be held the qualified intermediary or a third party escrow holder. Exchange funds, without exception, are placed in individual escrow accounts with a publicly traded and FDIC insured bank. Your account funds are never comingled. You receive a monthly bank statement and have the option of viewing your account online at the bank website. The account requires your approval for any withdrawal.

This is a common situation. Partners to an LLC want to effect a 1031 exchange and others want to cash out their ownership shares. While there are ways to structure transactions allowing members to trade their interest, by far the most common technique is for the outgoing partner to have the LLC redeem their interest and to convey by deed the applicable percentage interest in the property equivalent to the partners former share. The transfer to the partner and the subsequent trade by that person is generally referred to as a “drop and swap.”

IRS code doesn’t allow members/partners to do their own exchange, only the entire entity can do an exchange. With preplanning, there is a “drop & swap” technique we use where certain members/partners can drop their partnership interest from the entity and enter into the exchange individually and not as a member/partner.

Common closing expenses for a 1031 exchange are: real estate broker’s commissions, finder and referral fees, owner’s title insurance premiums, closing agent fees (title, escrow or attorney closing fees), attorney and tax advisor fees related to the sale or the purchase of the property, recording and filing fees, documentary or transfer tax fees, closing expenses which result in a taxable event including: pro-rated rents, security deposits, utility payments, property taxes and insurance, associations dues, repairs and maintenance costs, insurance premiums, loan acquisition fees: points, appraisals, mortgage insurance, lenders title insurance, inspections and other loan processing fees and costs.

No, the exchange is a like kind exchange of real estate for other real estate. Incidental costs such as loan related fees do not constitute the direct payment for like kind real estate.

To pay such fees out of the exchange account, the fee needs to meet two standards. First, the fee has to related only to legal services pertaining to the sale and/or purchase.

Second, the fee must be one that is typically found on a closing statement in the locale where the property transaction takes place.

In situations where the relinquished property sells for a greater value than the replacement property, it is possible for construction or improvement costs to reduce the taxable amount.

The default is that the payment of the tax is treated as an installment and payable in the year in which the funds were able to be paid out. Should a particular taxpayer wish to pay it in the first year to take advantage of tax losses in that year or for other reasons that can be done by a special election.

Some costs that pertain closely to the sale of the property like commissions, title insurance fees, closing fees, recording fees, transfer taxes, etc. can come out of the proceeds before the net amount is sent to the qualified intermediary

Exchangers sometimes want cash around the time of selling relinquished property as the first leg of an exchange. Funds paid to the taxpayer at closing are subject to taxation (known as boot). As an alternative, a taxpayer may wish to refinance the relinquished property before the exchange or refinance the replacement property after the exchange. However, in the absence of specific factors, refinancing the relinquished property is generally discouraged.

It is generally considered a bad idea to refinance in anticipation of entering into an exchange. By doing so, it changes the amounts on cash and debt that would need to be applied to the replacement property acquisition and may invite IRS attention. Waiting to refinance after an exchange to pull some equity out does not have these issues and is considered to be in better form.

If the buyer’s financing is taking more time than expected, this can be an attractive alternative. However, in a 1031 exchange, seller financing requires the use of a qualified intermediary and special attention to timing.

No, this is a common problem. Since for exchange purposes a taxpayer has to roll over all the net cash, the amount of the loan should be for the remainder of the purchase price.

In order to fully defer the gain, the sale price of the relinquished property, net of closing costs must be reinvested. For clarity, the net amount going into the exchange account must be reinvested and there has to be equal or greater mortgage debt on the new property compared to what was paid off upon closing of the old property.

All parties to the contract must receive notice of the assignment by the taxpayer of his/her interest. So if there are multiple parties selling or buying with the exchanger, those parties must get the notice of assignment as well as the counter party.

Yes, the purpose of adding the related party rules to the Tax Code was to prevent taxpayers from manipulating the tax result by buying replacement property from a related party such as a subsidiary company.

Yes, the related party rules to not include all relatives. Rather they disallow persons that are descendants or one another. Lineal descendants such as Parent, child, grandparents, siblings are considered related for this purpose, not so for in laws, aunts, uncles, cousins, etc.

A Reverse Exchange is the opposite of a forward exchange. It allows you to acquire your replacement property before you sell your current property. The structure is more complex than a delayed/forward exchange (sell first, buy second), it may give you the advantage to maximize your tax deferral by allowing your sell/relinquished property to appreciate 180 more days in value before you have to sell it.

An investor may need to consider a reverse exchange in a seller’s market, where properties are selling quickly and inventory is scarce. The most common variation (often called “parking the replacement property”) involves the Qualified Intermediary first purchasing the replacement property. When the relinquished property is sold at a later date, the Qualified Intermediary completes the exchange by deeding the replacement property back to the Exchanger.

No, the Reverse Exchange Rev. Proc. is very taxpayer friendly and relations between the intermediary (QI) and taxpayer do not have to be arm’s length. Typically, the (QI) will master lease the property to the taxpayer enabling the taxpayer to manage the property, collect the rent and pay for expenses.

The IRS issued a ruling years ago that said for purpose of the QI’s role in holding and transferring reverse exchange property, it could be considered the agent of the taxpayer and as a result extra transfer taxes did not need to be paid. There are a few states that still require payment regardless of the IRS ruling.

As a rule of thumb, it is generally easier to park the replacement property. However, when the taxpayer has financing set up for the replacement property that the lender will not allow to be in the name of the same name as the (QI), this cannot be done.

The short answer is yes. The reverse exchange allows the taxpayer to control the replacement property when the soon to be relinquished property cannot be sold first. A forward exchange is necessary to actually exchange the old property for the new property.

The short answer is no, due to tax code changes recently, only real estate can be the subject of a 1031 exchange. As a result, personal property such as a business or franchise cannot be the subject of exchanges.