Investors today routinely use the 1031 exchange process to leverage the sale of investment real estate or personal property. As of 2005, more than $200 billion of real assets changed hands through this mechanism, and millions of investors have benefited by preserving their equity. We have compiled for you a helpful list of some Do's and Don'ts for your next 1031 Exchange:
DO review the IRS Fact Sheet 2008-18, which we have compiled and added to our About Like-Kind Exchanges webpage, along with other helpful IRS and Internal Revenue Code Section 1031 information and materials.
DO use Qualified Intermediaries, or Exchange Accommodators. Fees usually range between $500 and $1,000 per exchange, depending upon the complexity of the deal. Qualified Intermediaries will work, hand in hand, with your real estate agents and brokers, and tax professionals and accountants.
DO advance planning for the 1031 Exchange. Speak in depth with your accountant, attorney, broker / real estate agent, lender and Qualified Intermediary. Remember, time is of the essence.
DO build your team and DO your research; have your real estate agent / broker do your due diligence, and not only evaluate not just the building, but the market where the property is located. Is it visible, what are the traffic counts, does it have road frontage or signage, what's possibility of re-letting the property if necessary. Evaluate the rent roll, lease terms, request estoppel certificates, etc. Evaluate market trends, demographics, and physically inspect the property.
DO insure for each 1031 Exchange, that individual accounts are established, like a Single Purpose Entity (SPE), making sure no commingling funds can happen, and with complete transparency at all times.
DO insure that your Qualified Intermediaries, or Exchange Accommodators have Errors and Omissions insurance. Every QI we work with has both experience and knowledge, carries Errors and Omissions insurance, and all escrow funds are held in FDIC insured accounts, and there must always be transparency.
DO identify the maximum number of properties. The Three Property Rule is where the purchaser identifies up to 3 replacement properties, regardless of their value; or if you have indentified more than 3 replacement properties, use the Two-Hundred-Percent Rule. Under the 200% Rule, the exchanger may identify more than 3 replacement properties, as long as the combined fair market value of all the properties is not more than 200% of the value of the relinquished property. It is always advisable to have a back up plan.
In a Reverse Exchange, DO use an Exchange Accommodation Titleholder to hold the replacement property, which is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.
If you sold your property, DO identify potential replacement properties, in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary, with in FORTY-FIVE (45) CALENDAR DAYS. Replacement properties must be clearly described in the written identification. In the case of real estate, this means a legal description, street address or distinguishable name.
If you sold your property, DO complete the exchange (the replacement property must be received) not less than ONE HUNDRED EIGHTY (180) CALENDAR DAYS after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.
DO make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property.
DO insure that all of the net proceeds from the sale of the relinquished property are used to acquire the replacement property.
DO instruct the closing agent to wire all of the proceeds from the sale to the Qualified Intermediaries.
DO report an exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with your tax return for the year in which the exchange occurred. If you do not specifically follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.
DON'T accept non like-kind
properties as replacement properties, feel free to checkout our 1031 Exchange - Like-Kind Examples webpage. Certain types of
property are specifically excluded from Section 1031 treatment. Section 1031
does not apply to exchanges of: Inventory or stock in trade, Stocks, bonds, or
notes, Other securities or debt, Partnership interests, nor Certificates of
trust.
DON'T use a Real Estate Mutual Fund or a REIT (Real Estate Investment Trust) as a replacement property. These do not qualify as like-kind replacement properties.
DON'T miss the replacement property identification and exchange deadlines. Failure to identify up to 3 properties within the 45 day replacement property identification period or failure to acquire the replacement property within the 180 day exchange period will disqualify the entire exchange.
DON'T accept any payments, funds, or proceeds until your Qualified Intermediary shows you that the Exchange is complete. It is important to know that taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable. The one way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete.
DON'T let your settlement agent hold the funds, not even in escrow. Only a Qualified Intermediary can hold the funds and complete the required paperwork. Most Qualified Intermediaries pay interest on your funds held in escrow. Qualified Intermediaries, or Exchange Accommodators fees are usually in the range of $500 and $1,000 per exchange, depending upon the complexity of the deal.
DON'T wait until your escrow is closed to contact a Qualified Intermediary or a Exchange Accommodator. Once Escrow closes, it is too late to begin a 1031 Exchange, and any gains realized, will be taxable.
DON'T file your income taxes for the year in which you do your 1031 Exchange until the Qualified Intermediary has notified you that exchange has completed. If you file beforehand, you could lose the benefits of the exchange.
This is not tax or legal advice and all information contained
herein is provided as a matter of courtesy and is for general information and
review purposes only. This is not legal or tax advice, please consult your tax
and or legal adviser, accountant and or attorney review your specific
transaction.
