Section 1031 of U.S. Internal Revenue Code: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”
Steps – 1031 Tax Deferred Exchange
Step #1 – Relinquished Property: Taxpayer/Exchanger must contact professional Accommodator to initiate a tax deferred exchange. The parties will enter into an Exchange Agreement, which describes the guidelines, duties and responsibilities of both parties relating to the exchange. In addition, the Taxpayer/Exchanger will choose their payment option in the Exchanger’s Instructions to the Accommodator. Prior to the closing, Taxpayer/Exchanger will sign the Amended Escrow Instructions to assign to the Accommodator into the contract, as the seller. After these documents are signed by all parties, escrow can close and transfer the proceeds from the relinquished property to the Accommodator.
You should also determine who is handling your 1031 tax deferred exchange (the accommodator) and its bank, whether that bank insures all non-interest bearing funds, regardless of the amount.
Step #2 – ID Period & Rules: The Taxpayer/Exchanger has forty-five (45) days from the close of their relinquished property, to identify their replacement property. While identifying their replacement property, the Taxpayer/Exchanger may choose between the following two rules:
1. Three Property Rule – A maximum of three replacement properties may be identified without regard to the fair market value of the properties.
2. Two Hundred Percent Rule – Any number of properties may be identified, so long as the aggregate fair market value of the replacement properties identified does not exceed two hundred percent of the aggregate fair market value of the relinquished property.
Exception: No formal identification is necessary if Exchanger can acquire all replacement property(ies) within 45 days from the close of escrow of the relinquished property.
Step #3 – Replacement Property: After the Taxpayer/Exchanger has chosen their “like Kind” replacement property. Taxpayer/Exchanger will sign the Amended Escrow Instructions to assign Accommodator into the contract as the buyer. When the escrow is set to close, the Accommodator will deposit exchange funds into escrow. If escrow needs additional funds the Taxpayer/Exchanger may either deposit funds directly into escrow or obtain financing. The replacement property must be acquired on or before the following:
1. The replacement property must close escrow prior to 180 days from the date of the relinquished property close of escrow, or
2. The due date of Exchanger’s federal income tax return(taking into account any extensions) for the fiscal year the relinquished property is transferred.
1031 Exchange Requirements:
- Purchase equal or greater in net sales price (value)
- Reinvest all of the net equity in the replacement property
- Obtain equal or greater debt on the replacement property
Exception: A reduction in debt can be offset with additional cash. However, increasing debt cannot offset a reduction in equity.
For other information see IRS Rules on 1031 Exchanges see article – click here.
This is for information only with general guidelines and is not the providing of financial advice, tax or legal services. Always consult with your tax advisor and/or attorney before entering a 1031 tax deferred exchange.
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Harrison K. Long – Professional real estate representative, REALTOR and broker associate, HomeSmart Evergreen Realty – 949-854-7747 (phone) – ExploreProperties@gmail.com – CALBRE #01410855 – also an attorney member of the California State Bar association #69137