Demistifying 1031 Exchange

July 12, 2017 | Iulia Zecheru

1031 Exchange

A 1031 Exchange is when you sell a property and buy another “like-kind” property within a certain period of time following specific rules. A 1031 tax exchange provides exceptions and tax deferments for like-kind exchanges, which refer to the process of swapping one business or investment asset for another.

Basic requirements:
1. Property qualifications
– The property is for productive use in trade or business or for investment;
– It needs to be “like kind” property (for example, a condo can be exchanged for a single-family home)
– Holding period needs to be 1-2 years.
2. Tax deferral requirements: the investor needs to invest all the cash; the purchase price is equal to or greater than replacement property’s sale value
3. Timeline: the investor has 45 days to identify the replacement property after the close of escrow and 180 days to make the exchange. These dates are non-negotiable: if you can identify your properties in 45 days or can’t close in 180 days, then the 1031 exchange isn’t valid.
0                                                                 45                                                                                                     180
I——————————————-I——————————————————————–I
Close of                                              Identification                                                                               Exchange
Escrow                                                Letter Due                                                                                    Completed

4. Identification can be made in 2 ways:
– 3 Property rule – the investor needs to choose 3 properties to make the exchange. No substitutions or changes can be made after day 45.
– 200% Property rule – if the investor would like to nominate more than 3 properties, he can choose more properties, but all of them can’t add up to more than 200% of the property sold.
Example: if the investor sold a $1 Million house, the properties on the list can’t exceed $2 Million.
– 95% Closing rule – you can identify as many properties, but you have to close on 95% of them.

A very important factor in this process is the Asset Exchange Company that needs to be involved before escrow closes on the property that will be exchanged to qualify for the exchange. If escrow writes the seller a check, he can no longer qualify for an exchange. Finding a good Qualified Intermediary (QI) is a key factor to this whole process. The QI is the middle man through this exchange process. The selling process is similar to the regular selling process, with a small difference: the QI is the go-through person.

Property Taxes, Sellers