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| AAHH Montana Real Estate |
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What is a 1031 Exchange?
A Tax-Deferred Exchange represents a simple, strategic method for selling one qualifying
property and the subsequent acquisition of another qualifying property within a specific time
frame. Essentially, if you sell an investment property and use the proceeds to purchase a
Like-Kind investment property, you can avoid paying State and Federal income taxes. This is
the most common scenario for the 1031 exchange and it referred to as a Delayed Exchange.
Prior to selling the investment property, the taxpayer should consult a tax and/or
legal advisor to determine the tax ramifications of their transaction and the
relevancy to their retirement plan.
Generally, an investment property sold after a year and a day of ownership would have long
term capital gains. If a property is sold within one year, the gains would be taxed at a rate of
ordinary income.
A Tax-Deferred Exchange represents a simple, strategic method for selling one qualifying
property and the subsequent acquisition of another qualifying property within a specific time
frame. Essentially, if you sell an investment property and use the proceeds to purchase a
Like-Kind investment property, you can avoid paying State and Federal income taxes. This is
the most common scenario for the 1031 exchange and it referred to as a Delayed Exchange.
Prior to selling the investment property, the taxpayer should consult a tax and/or
legal advisor to determine the tax ramifications of their transaction and the
relevancy to their retirement plan.
Generally, an investment property sold after a year and a day of ownership would have long
term capital gains. If a property is sold within one year, the gains would be taxed at a rate of
ordinary income.
For the Delayed Exchange, the following outlines the steps of the exchange.
1. Talk to Tax Advisor and/or Legal Advisor
2. List property for sale
3. Open escrow with Title Company
4. Open exchange during escrow with Qualified Intermediary
5. Sign Exchange Agreement at the Close of Escrow (C.O.E.)- During C.O.E., the seller will
deed the property directly to the buyer
6. ID replacement property within 45 days of C.O.E.
7. Close on replacement property within 180 days of C.O.E.
1. Talk to Tax Advisor and/or Legal Advisor
2. List property for sale
3. Open escrow with Title Company
4. Open exchange during escrow with Qualified Intermediary
5. Sign Exchange Agreement at the Close of Escrow (C.O.E.)- During C.O.E., the seller will
deed the property directly to the buyer
6. ID replacement property within 45 days of C.O.E.
7. Close on replacement property within 180 days of C.O.E.
For a transaction to qualify for tax-deferred treatment under Section
§1031, certain requirements must be met:
*The property must be "Like-Kind"
*Minimum reinvestment requirements
*Specific time frame must be followed
*Exchange Property Identification Rules
*A specific holding period must be met
*You must use a Qualified Intermediary
Scroll down for further information
§1031, certain requirements must be met:
*The property must be "Like-Kind"
*Minimum reinvestment requirements
*Specific time frame must be followed
*Exchange Property Identification Rules
*A specific holding period must be met
*You must use a Qualified Intermediary
Scroll down for further information
THE PROPERTY MUST BE "LIKE-KIND"
Replacement property acquired in an exchange
must be like-kind to the property being relinquished.
The words "like-kind" refer to the nature or
character of the property and not to its grade or
quality. In an exchange "like-kind" only applies to
real property that has been used for business,
trade, or investment purposes. Almost all real estate
qualifies for an exchange.
There is some flexibility in this definition. Although
the properties involved in an exchange must be
like-kind, they do not need to be exactly alike. Below
is a list of properties that can all be exchanged with
one and other:
*Single-Family Rentals
*Industrial Buildings
*Golf Courses
*Retail Space
*Farms and Ranches
*Hotels and Motels
*Leases with 30 years +
*Multi-Family Rentals
*Offices
*Land
Replacement property acquired in an exchange
must be like-kind to the property being relinquished.
The words "like-kind" refer to the nature or
character of the property and not to its grade or
quality. In an exchange "like-kind" only applies to
real property that has been used for business,
trade, or investment purposes. Almost all real estate
qualifies for an exchange.
There is some flexibility in this definition. Although
the properties involved in an exchange must be
like-kind, they do not need to be exactly alike. Below
is a list of properties that can all be exchanged with
one and other:
*Single-Family Rentals
*Industrial Buildings
*Golf Courses
*Retail Space
*Farms and Ranches
*Hotels and Motels
*Leases with 30 years +
*Multi-Family Rentals
*Offices
*Land
MINIMUM REINVESTMENT REQUIREMENTS
Real property that is sold must be replaced with
real property. Also, as a rule of thumb the value of
what is bought must be equal to or greater than
the value of what is sold, less closing costs.
Basically all proceeds from the sale of the
relinquished property must be re-invested into the
new property rather than sold for cash. If any
proceeds are left over or used for other purposes
they are considered a gain and are subject to
taxation. If this is the case, the transaction is a
partial tax-deferred exchange.
In general, IRC section 1031 provides that you
must exchange for "like-kind" property. You must
acquire a property with loans, equity, and sales
price which are equal or greater that the property
exchanged.
Real property that is sold must be replaced with
real property. Also, as a rule of thumb the value of
what is bought must be equal to or greater than
the value of what is sold, less closing costs.
Basically all proceeds from the sale of the
relinquished property must be re-invested into the
new property rather than sold for cash. If any
proceeds are left over or used for other purposes
they are considered a gain and are subject to
taxation. If this is the case, the transaction is a
partial tax-deferred exchange.
In general, IRC section 1031 provides that you
must exchange for "like-kind" property. You must
acquire a property with loans, equity, and sales
price which are equal or greater that the property
exchanged.
A SPECIFIC TIME FRAME MUST BE FOLLOWED
Beginning with the close of the relinquished
property, you have 45 days to identify in writing the
properties you intend to purchase and 180 days
(or the due date for your tax return - whichever is
earlier) to complete the acquisition of one or more
of those properties. In addition, the 45 day
identification period and the 180 day exchange
period are calendar days. If the 45th day or 180th
day falls on a weekend or holiday, the deadlines
still apply. There are no extensions for Saturdays,
Sundays, or legal holidays.
Beginning with the close of the relinquished
property, you have 45 days to identify in writing the
properties you intend to purchase and 180 days
(or the due date for your tax return - whichever is
earlier) to complete the acquisition of one or more
of those properties. In addition, the 45 day
identification period and the 180 day exchange
period are calendar days. If the 45th day or 180th
day falls on a weekend or holiday, the deadlines
still apply. There are no extensions for Saturdays,
Sundays, or legal holidays.
EXCHANGE PROPERTY IDENTIFICATION RULES
Three basic rules serve to limit the number of
properties that can be identified. The Taxpayer shall
identify only that number of Replacement Properties
which meets one of the "rules" set forth below:
The Three-Property Rule -Three (3) Replacement
Properties without regard to the fair market value of
the Properties. For those who identify more than three
properties, the next two rules apply.
The 200% Rule - Any number of Properties so long as
their aggregate fair market value as of the end of the
Identification Period does not exceed two hundred
percent (200%) of the aggregate fair market value of
the Relinquished Property as of the date the
Relinquished Property was transferred by the
Taxpayer.
The 95% Rule - Any number of Properties without
regard to their aggregate fair market value so long as
the Taxpayer received identified Replacement
Properties constituting at least ninety-five (95%) of
the aggregate fair market value of all identified
Replacement Properties before the end of the
Exchange Period.
The Three-Property Rule is by far the easiest of the
three rules.
Three basic rules serve to limit the number of
properties that can be identified. The Taxpayer shall
identify only that number of Replacement Properties
which meets one of the "rules" set forth below:
The Three-Property Rule -Three (3) Replacement
Properties without regard to the fair market value of
the Properties. For those who identify more than three
properties, the next two rules apply.
The 200% Rule - Any number of Properties so long as
their aggregate fair market value as of the end of the
Identification Period does not exceed two hundred
percent (200%) of the aggregate fair market value of
the Relinquished Property as of the date the
Relinquished Property was transferred by the
Taxpayer.
The 95% Rule - Any number of Properties without
regard to their aggregate fair market value so long as
the Taxpayer received identified Replacement
Properties constituting at least ninety-five (95%) of
the aggregate fair market value of all identified
Replacement Properties before the end of the
Exchange Period.
The Three-Property Rule is by far the easiest of the
three rules.
A SPECIFIC HOLDING PERIOD MUST BE MET
The general rule is that a taxpayer must hold
the property for at least two years before it can
be considered for tax-deferred treatment. This
rule applies both to the relinquished and
replacement properties.
There is a more strict time requirement when
related parties are involved-when selling to a
related party, the related party must hold the
relinquished property for at least two years.
Selling the property prior to the two year mark
will disallow the exchange.
The general rule is that a taxpayer must hold
the property for at least two years before it can
be considered for tax-deferred treatment. This
rule applies both to the relinquished and
replacement properties.
There is a more strict time requirement when
related parties are involved-when selling to a
related party, the related party must hold the
relinquished property for at least two years.
Selling the property prior to the two year mark
will disallow the exchange.
YOU MUST USE A QUALIFIED INTERMEDIARY
As stated by the IRS, a Qualified Intermediary
must be used in every exchange, even if the
Taxpayer has identified a replacement property
prior to selling the old property.
The Qualified Intermediary acts as the
non-biased third party during an exchange
transaction. The intermediary holds all funds
and prepares any necessary documentation
pertinent to the exchange. If at any time the IRS
feels that the Taxpayer has been in direct
contact with the proceeds from the sale of the
relinquished property, the exchange will be
disallowed. For this reason, it is extremely
important that a trusted Qualified Intermediary is
used.
As stated by the IRS, a Qualified Intermediary
must be used in every exchange, even if the
Taxpayer has identified a replacement property
prior to selling the old property.
The Qualified Intermediary acts as the
non-biased third party during an exchange
transaction. The intermediary holds all funds
and prepares any necessary documentation
pertinent to the exchange. If at any time the IRS
feels that the Taxpayer has been in direct
contact with the proceeds from the sale of the
relinquished property, the exchange will be
disallowed. For this reason, it is extremely
important that a trusted Qualified Intermediary is
used.