Basics of a 1031 Tax-Deferred Exchange…
Qualified Intermediary…
As a qualified intermediary, there are several areas involving Tax-Deferred Exchanges where we are not able to advise you or your client. The IRS requires that we remain an independent third party to your exchange transaction. In that capacity, we are a qualified party that can facilitate your exchange transaction. A disqualified party is defined by the IRS as an agent, if the person in the previous two years has served as the Exchangor’s employee, attorney, accountant, investment banker/broker or real estate agent/ broker. Also disqualified are parties, which are related lineally or as siblings or through a ten percent or greater interest in a business sense.
We do suggest you always consult your attorney and tax advisor for specific details regarding your financial situation. Then contact a qualified intermediary to handle your exchange transaction.
What we can do for you as your Qualified Intermediary/Accommodator…
- Provide free consultations regarding your real estate transaction and let you know how it will fit into a 1031 Tax-Deferred Exchange.
- Advise you of the do’s and don’ts defined by the IRS and discuss the many gray areas that arise when attempting to fit your real estate transaction within the guidelines of a 1031 tax-deferred exchange.
- Provide you with our written materials regarding 1031 Tax-Deferred Exchanges for your review and discuss any questions you may have.
- Contact your attorney, tax-advisor, or real estate professional to discuss your real estate transaction.
- Coordinate your 1031 exchange closing with the escrow closer or attorney of your choice and provide the necessary exchange documentation needed.
- Instruct the escrow closer or attorney on how to prepare your closing documentation and what to do with your exchange proceeds.
- Hold your exchange proceeds in an interest-bearing account where each client earns interest.
General Exchange Information…
When the proceeds from the sale of real property or personal property are used to purchase other like-kind property, you should consider a Tax-Deferred Exchange. The IRS recognizes the use of an Accommodator or Qualified Intermediary as a safe harbor for your transaction. The sale and purchase of property held for use in a trade or business or for investment purposes can be done as a delayed exchange, reverse exchange or a simultaneous exchange. All three qualify for tax-deferred treatment.
There are important guidelines and tricky pitfalls you need to be aware of if you want total tax-deferment. Pioneer 1031 Company can help you set up a 1031 Tax-Deferred Exchange as well as explain the steps for your particular exchange. Although we cannot give specific tax advice, we do give consultations free of charge. Please give us a call with your questions.
Defining Like-Kind Real Property…
Like-Kind Requirement: Replacement property acquired in an exchange must be “like-kind” to the property being sold (relinquished property). Like-kind means “similar in nature or character, notwithstanding differences in grade or quality.” In order for the properties to qualify as “like-kind,” they must be held for productive use in a trade or business or held for investment purposes and be located within the United States. Foreign property does not qualify. For example: raw land held for investment may be exchanged for single family rentals or any combination of the below examples:
- Single Family Rentals
- Farms/Ranches
- Offices
- Motels/Hotels
- Golf Courses
- Multi Family Rentals
- Raw Land
- Retail
- Industrial
- Leases of 30 years or more
Property not eligible under 1031…
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- Primary Residence
- Secondary Residence not held for investment purposes
- Interest in Partnerships
- Personal Property
- Foreign Property
- Money
- Stocks, Bonds, or Notes
- Stock in trade, inventory or other property held inherently for sale
Section 1031 of the Internal Revenue Code, Sec. 1031 [1986 Code] 1031 – Exchange of property held for productive use or investment (a) Non-recognition of Gain or Loss from Exchanges Solely in Kind.
(1) IN GENERAL – 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.
(2) EXCEPTION – This subsection shall not apply to any exchange of a stock in trade or other property held primarily for sale.
- stocks, bonds, or notes
- other securities or evidences of indebtedness or interest
- interest in a partnership
- certificates of trust or beneficial interests
Timeframes…
To do an Exchange, you need to keep in mind there are two very important time restrictions: the 45-day identification period and the 180-day exchange period. When you violate one of these time periods, your exchange fails. These time restrictions are carved in stone. The only exception is in the event of a natural disaster and the federal government issues an extension.
Your total exchange period is 180 days from the date the warranty deed recorded on your relinquished property(ies) in a delayed exchange or on your replacement property(ies) in a Reverse Exchange, when the EAT is taking title. To complete your exchange, you must have a recorded warranty deed to complete your exchange before midnight of the 180th day. In some cases, you will need to file for an extension for filing your income tax return in order to receive the entire 180 days in a delayed exchange. From the date of recording of the Warranty Deed on your initial property(ies), the 45-day identification period begins.
From that time, you have only 45 days to identify in writing to your Accommodator, the property or properties you wish to purchase, or sell, to complete your exchange. The trick is complying with the strict rules in completing your identification notice. As your Accommodator (Intermediary), we can instruct and help you comply with those rules.
IRS Guidelines…
1. Equal or Greater Property Value
Replacement property fair market value must be equal to or greater than the fair market value of the relinquished property. If you wish to acquire property of less value, you may. But please speak with your tax advisor regarding possible tax consequences.
2. Use All Proceeds From the Sale
You must use all of your exchange proceeds from the sale of the relinquished property to acquire your replacement property. If you would like to receive cash for personal use, you must make arrangements prior to the disbursement of sale proceeds by the escrow closer. Under the exchange regulations, you may not have the ability to control or direct funds in any way once proceeds have been sent to the exchange facilitator. Remember, you should only use exchange proceeds to acquire real property. Speak with your tax advisor regarding possible tax consequences of taking exchange funds for personal use.
3. Equal or Greater Debt
Your replacement property debt (mortgage) must be equal to or greater than your relinquished property debt (mortgage). You may acquire less or no debt on your replacement property, but you should speak with your tax advisor regarding possible tax consequences of “debt relief.” The guidelines listed above are to be used to help you effectuate a Tax-Deferred Exchange. If you don’t meet all the guidelines, you may still do an exchange, but you may be subject to tax on the difference. The IRS has defined several black and white areas, but there are many more gray areas, which are difficult to elaborate on without details about your specific tax situation. We highly recommend you seek specific tax advise from your tax advisor or attorney, particularly when attempting a partial exchange.
Steps for a Successful
1031 Tax-Deferred Real Estate Exchange…
STEP 1: Before you close, PIONEER 1031 COMPANY WILL NEED A COPY OF YOUR SALES CONTRACT BETWEEN THE SELLER (EXCHANGOR) AND THE BUYER ALONG WITH A COPY OF THE PRELIMINARY TITLE REPORT.
As with any sale of real property, you need to have a written contact between the parties involved. Further it is imperative to make sure that your Sales Contract is assignable for the purposes of the 1031. Once you have a sales contract, your realtor will open escrow with a title and escrow company of your choice. Pioneer 1031 Company will then prepare your 1031 Exchange documents and have them ready and waiting at the title or escrow company when you arrive for your closing. You can, of course, review the documents ahead of time.
Once you have a sales contract, your realtor will open escrow with a title and escrow company of your choice. Pioneer 1031 Company will then prepare your 1031 Exchange documents and have them ready and waiting at the title or escrow company when you arrive for your closing. You can, of course, review the documents ahead of time.
STEP 2: MAKE AN APPOINTMENT WITH YOUR ESCROW OFFICER FOR THE SIGNING OF YOUR ESCROW DOCUMENTS.
We will instruct your escrow officer on how to complete this “Phase I” of your tax-deferred exchange. She or he will forward your exchange funds directly to Pioneer 1031 Company upon the recording of the warranty deed. Pioneer 1031 Company will invest your funds in an interest-bearing account at a federally insured financial institution.
STEP 3: COMPLETE YOUR IDENTIFICATION NOTICE AND DELIVER TO PIONEER 1031 COMPANY.
The day your warranty deed records is the day your 45-day identification period and your 180-day exchange period begins. You can identify your replacement property or properties in writing anytime up to midnight on your 45th day. Make sure Pioneer 1031 Company receives it by mail, by fax or by delivery before or on your deadline! No exceptions! (ID notice can be emailed.)
STEP 4: PIONEER 1031 COMPANY WILL NEED A COPY OF YOUR ASSIGNABLE REPLACEMENT PROPERTY PURCHASE CONTRACT AND PRELIMINARY TITLE REPORT.
You must complete this Phase II of your exchange anytime before midnight of your 180-day exchange period deadline. Through your closing agent, we will disburse your exchange proceeds for your purchase.
Tips for a Successful 1031
Tax-Deferred Real Estate Exchange…
The IRS has defined several black and white areas dealing with a 1031 tax-deferred real estate exchange, however there are many more gray areas which are difficult to elaborate on unless you have detailed questions about your own exchange. We highly recommend that you seek specific tax advice from your tax advisor or attorney. To be a qualified intermediary (accommodator), we must remain an independent third party to your transaction and cannot act in any way as your real estate agent, tax advisor, or attorney.
We do consider ourselves a team by working closely with your real estate agents, tax advisors, attorneys, escrow officers and lenders. At Pioneer 1031 Company our consultations are free of charge, whether by phone, email, or in person.
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- The related party problem creates a two-year mandatory holding period if you buy from or sell to a related party (actual relatives and controlled entity).
- When you sell real or personal property, be aware about the recapture of any prior depreciation. Part of your gain may be taxes as a capital gain and qualify for the maximum 15% rate on long-terms gains. However, part of the gain that is related to depreciation will be recaptured at a maximum 25% rate. You can use our Capital Gains Calculator to arrive at an estimate of your capital gain tax and depreciation recapture amount. That tax liability could be deferred by using a tax-deferred exchange.
- A dealer trap occurs when you develop land. You may lose 1031 opportunity if the IRS determines that the land is strictly inventory.
- A partnership pitfall prevents an individual partner seeking to exchange his interest in the partnership’s r.e. assets for like-kind real estate he wants to acquire in his name individually. Therefore, a partnership’s interest is not eligible exchange properties. However, the partnership itself can exchange partnership property.
- The reverse exchange occurs when a taxpayer acquires the replacement property before selling the relinquished property. When you build, you are limited by the 180-day period. In addition, you cannot exchange into an improvement built-on-land that you already own.
- Seller Carry Back financing can be taxable on the “Installment Sale Basis.” If, as the Seller/Exchangor, you chose to have the note payable to you at closing. But the carry back can be included in the exchange and qualify for tax deferment if the exchange and closing are set up correctly. We suggest that you contact us to discuss the possibilities. Then place the next call to your accountant for their guidance.
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A special note for clients in Washington State…
“WASHINGTON STATE LAW, RCW 19.310.040, REQUIRES AN EXCHANGE FACILITATOR TO EITHER MAINTAIN A FIDELITY BOND IN AN AMOUNT OF NOT LESS THAN ONE MILLION DOLLARS THAT PROTECTS CLIENTS AGAINST LOSSES CAUSED BY CRIMINAL ACTS OF THE EXCHANGE FACILITATOR, OR TO HOLD ALL CLIENT FUNDS IN A QUALIFIED ESCROW ACCOUNT OR QUALIFIED TRUST THAT REQUIRES YOUR CONSENT FOR WITHDRAWALS. ALL EXCHANGE FUNDS MUST BE DEPOSITED IN A SEPARATELY IDENTIFIED ACCOUNT USING YOUR TAX IDENTIFICATION NUMBER. YOU MUST RECEIVE WRITTEN NOTIFICATION OF HOW YOUR EXCHANGE FUNDS HAVE BEEN DEPOSITED. YOUR EXCHANGE FACILITATOR IS REQUIRED TO PROVIDE YOU WITH WRITTEN DIRECTIONS OF HOW TO INDEPENDENTLY VERIFY THE DEPOSIT OF THE EXCHANGE FUNDS. EXCHANGE FACILITATION SERVICES ARE NOT REGULATED BY ANY AGENCY OF THE STATE OF WASHINGTON OR OF THE UNITED STATES GOVERNMENT. IT IS YOUR RESPONSIBIITY TO DETERMINE THAT YOUR EXCHANGE FUNDS WILL BE HELD IN A SAFE MANNER.” RCW 19.310.040(1)(b) (as amended).
→ View more information on Exchange Facilitator Regulations in the State of Washington.
Certificate of Insurance / Fidelity Bond and Errors & Omissions) for Pioneer 1031 Co can be provided upon request.