1031 Exchange Education - The 1031 Investor

1031 Exchanges and Conversion Into a Primary Residence

November 11, 2022

Many people know about the primary residence exclusion that allows them to take the first $250,000 in profit ($500,000 if you’re married) tax free after just two years of occupancy. And more and more people are learning about the opportunity to do that repeatedly. But, did you know that you can convert an investment property into your primary residence and take advantage of that tax break? Even if you used a 1031 Exchange into your investment property, it’s still an option.

Converting from Investment to Primary Residence

Here’s the deal on converting investment property into your primary residence:

If you purchased the investment without a 1031 Exchange, you may change its use at any time. Simply use the property as your primary residence for two of the five years immediately preceding its sale.
If you purchased the property with a 1031 Exchange, there are some special rules for the conversion and the exclusion is prorated.

Converting after a 1031 Exchange

As you may recall, you cannot use a 1031 Exchange to purchase a property you intend to use for your primary residence. You must use the 1031 to purchase property you intend to use for investment purposes.

However, you can convert a 1031 property into your primary residence after holding it for productive use in business or trade for a period of time. The key is:

your initial intent to hold it for investment purposes and
how you demonstrate that intent.

For example, if you 1031 into a property and then move right in, what was your demonstrated intent? To use it as your primary residence. Both your initial stated intent and your actions subsequent to purchase are key.

Special Rules after a 1031 Exchange

If you 1031 into a property and then use it as a rental for the next 24 months and do not use it for personal use more than 2 weeks or 10% of the number of days it is actually rented, then the IRS gives you a safe harbor and will never challenge your initial intent. In between day one and two years, there is a wide range of time for you to decide if you’ve owned it long enough and treated it as investment enough that you can change your intent and move in. An awful lot of folks feel good at anything more than a year. But, individual circumstances could allow a shorter (or longer) investment use period.

When you do convert the property into your primary residence, you will then get the benefit of the primary residence exclusion with some 1031 Exchange specific requirements.To qualify for any of the primary residence exclusion, you must have owned the converted property for no less than five years. In addition, you must have lived in it for two out of the five years prior to sale. And then you get to prorate the amount of gain between the period of “qualified use” (as a primary and tax-free) and “non-qualified use” (as an investment and you would pay tax on this portion). You also have to recapture all depreciation.

The Bottom Line

The conversion of an investment property into a your primary residence is an underutilized option that can be very beneficial. Over time, it can make the capital gains tax on your former investment property dwindle. This give you the opportunity to take all or a portion of your home sale proceeds tax-free.

Questions? Give us a call at 850-889-1031 or find a mutually convenient time via our online scheduler.

As always, consult with your accountant to determine the best course of action for your financial situation.

3 Myths That Haunt 1031 Exchanges

October 31, 2022

Think tax-deferred 1031 Exchanges of real estate are too new, sketchy or scary to try? Every week, I talk to investors just like you who are surprised to learn that:

1. 1031 Exchanges have been around longer than IRAs and 401(k)s;
2. 1031 Exchanges are 100% legal; and,
3. 1031 Exchanges can be completed by novice investors.

Here are some myths I confront every day:

Myth #1: 1031 Exchanges Are Too New To Be Trusted

In 1921, Congress enacted The Revenue Act which authorized the exchange of like-kind property without paying tax. It was added to the Internal Revenue Code (IRC) Section 1031 and “1031 Exchanges” were born.

These transactions were originally used by cash-poor farmers to allow for the “exchange” of investment real estate without paying tax on the gain. In the intervening 98 years, IRC 1031 rules and regulations have evolved to serve today’s real estate investors. As we approach the 100th anniversary of 1031 Exchanges, the myth of their novelty should be retired.

Myth #2: 1031 Exchanges Are Sketchy

1031 Exchanges are not a “tax loophole”. Like your 401k or IRA, the tax deferral benefits of a 1031 Exchange are government endorsed and sponsored. As times have changed, the ways in which 1031 Exchanges can be successfully conducted have been both clarified and refined. Your 1031 Exchange qualified intermediary can guide you through the specific steps of this legal transaction.

Myth #3: 1031 Exchanges Are Scary

Most investors I talk to tend to be annoyed by the restrictions imposed on their IRA or 401(k) rather than fearful of the tax-deferred retirement provisions in the law. Same with 1031 Exchanges – there are specific rules and regulations. Some of these are maddening and some of them are pesky, but millions of investors have navigated them successfully. If you have never completed a 1031 Exchange, don’t be put off or intimidated by unfamiliarity.

In the course of your real estate investing career, you may find yourself selling your appreciated or depreciated investment real estate and purchasing replacement investment real estate. Why not keep your taxes working for you in that transaction? Follow the 1031 Exchange rules and regulations and you can indefinitely defer payment of the tax that would normally be due on sale and grow your portfolio using Uncle Sam’s money. Its time tested, legal and entirely within your capabilities.

Myth busted!

To find out more about 1031 Exchanges and how they can benefit you call us at 850-889-1031 or use our online calendar to schedule an appointment with an exchange specialist.

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Choosing Your Qualified Intermediary

October 26, 2022

5 Things to Look For In Your Qualified Intermediary

Before you can begin your 1031 exchange, you will have to select a Qualified Intermediary (QI). A good QI can make or break your exchange. To ensure that everything goes smoothly it is important to make sure that your Qualified Intermediary is actually qualified. Here are five things to look for in a QI.

1. They should use a segregated, qualified escrow account (at no charge)

Make sure that the QI you select does not have a pooled exchange account. It is important to ensure that your exchange account is not comingled with someone else’s funds. Your QI should have a segregated qualified escrow account so that only your money is in that account and it is identifiable to you.

2. They should guarantee their exchange

Your Qualified Intermediary should do everything in their power to ensure that your exchange is successful. A good QI should be able to assure you that your exchange will be carried out without a hitch.

3. Audit protection – providing support and documentation if needed (at no charge)

Make sure that the QI you select keeps their records and documents tidy. Should an audit occur, you want to be certain that your QI has all the documentation you need.

4. They must be easily accessible to answer questions (at no charge)

Avoid Qualified Intermediaries with poor communication skills. You want your QI to be reachable and ready to answer any questions that you might have. Keep track of how long it takes them to answer phone calls and emails. They should be responsive to your inquiries as they are holding your hard earned profits.

5. Experience

You want to look for a QI who has experience, a reputation in the industry, and who has demonstrable results. Do not select a Qualified Intermediary who does not have a history to back up their claims.

Selecting a good QI is a key step in ensuring that your 1031 goes as planned. If you select the right QI to guide you through the process, you can focus on your real estate investing as they handle documentation.

To learn more about how you can utilize the power of a 1031 Exchange call us now at 850-889-1031 or click here to schedule your free consultation.

How to Complete a Partial 1031 Exchange

October 11, 2022

A 1031 exchange doesn’t have to be an all-or-nothing move. It is possible to complete a partial 1031 exchange that allows you to either take cash out, purchase less than you sold, or both.

But there are tradeoffs. Completing a partial exchange creates a tax liability you will want to thoroughly understand before moving forward. This article will help you determine if it is a good fit for your personal and financial goals.

Join our partial exchange webinar! Or keep reading to find out what a partial 1031 exchange is and then walk through the process.

What is a 1031 Exchange?

A 1031 exchange allows you to defer all federal capital gains tax and depreciation recapture when you sell an investment property and purchase a replacement investment property of equal or greater value using all the cash proceeds in that purchase.

What is a Partial 1031 Exchange?

A partial 1031 exchange lets you defer part of the federal capital gains tax and depreciation recapture that would have been due on sale.

A partial 1031 exchange occurs when either the relinquished property proceeds are not all expended on replacement(s) or the value of the replacement(s) is less than the net sales price.

The portion of the exchange proceeds not reinvested is called “boot” and is received by the exchanger as either cash or payment of costs not eligible for tax deferral. The difference is subject to capital gains tax and depreciation recapture.

You may have solid personal or business reasons to complete a partial exchange intentionally. With planning, it may be a good way to meet your objectives. When completing a partial exchange, you can opt to take some cash out or purchase a less costly replacement property and still defer some of the tax.

How Can You Do a Partial 1031 Exchange?

A partial exchange has the same basic requirements and steps as a regular exchange. However, at some point in the process, you decide to take cash out or purchase less than you sold.

Taking Cash Out

Because a 1031 exchange requires that you do not have constructive receipt of sale proceeds, once an exchange is initiated, there are typically just a few opportunities to take cash out. Those opportunities might be:

At the closing table of your sale
After day 45, whenever you finalize the purchase of all replacement properties and have funds left in your account
The first business day after day 180

Note that these cash-out opportunities should be explicitly spelled out in the exchange agreement with your Qualified Intermediary (QI). If you intend to execute a partial exchange, make this aspect part of your QI selection process so your funds are not held up unnecessarily until after day 180.

At the Closing Table of Your Sale

If you know the amount you wish to take out in cash, the earliest opportunity to do so is at the closing table of your relinquished property sale. To receive cash back at that time, you would simply let your QI and closing agent know of your intent and specify the amount you wish to have distributed directly to you. The QI will typically prepare a “Boot Addendum” for you to complete at the closing table, and the closing agent will need information on where to transfer funds/how to make out the payment.

However, if your goal is to put down a specific percentage on your replacement property, it is unlikely that amount will be known at the time you close your sale. In that case, you may choose to have all proceeds transferred to the QI and receive the cash back at the first allowable opportunity after closing on your purchase(s).

After Your 45-Day Identification Deadline and Purchase of All Identified Properties

Depending on the exchange agreement with your QI, after you have closed on all identified property, you may receive any remaining proceeds back as cash as early as the first business day after your 45-day identification deadline.

If your purchase happened well before the 45-day identification deadline, receipt of remaining proceeds on the first business day after that deadline is likely—so long as you provide advance notice of your intent and supply all transfer details to your QI ahead of time.

However, if your purchase happens close any time after your 45-day identification deadline, the transfer may not be possible for several days or weeks after closing, depending on when your closing agent returns all closing documents to the QI.

Purchase Less Than You Sold

The other way to complete a partial exchange is to purchase less than you sold. Even if you use all cash proceeds in the purchase, buying replacement property for less than the net sales price of your relinquished property constitutes a partial exchange and creates a taxable event.

Example: Cash-Out

An example of a cash-out partial exchange would be the net sale of relinquished property for $1,000,000 with $100,000 cash out at the closing table. Your exchange documentation would reflect that $100,000 went directly into your pocket. This creates two aspects of the sale: the $900,000 exchange portion and the cash out of $100,000. The $100,000 in your pocket is taxable.

In this instance, your reinvestment target would be the net sales price of $1,000,000 less the $100,000 cash out, so you would need to purchase as much or more than $900,000 to defer the remaining tax on the gain and depreciation recapture.

Example: Reinvestment Purchase Less than Net Sale

An example of a purchasing less than the net sale partial exchange would be the net sale of relinquished property for $1,000,000 followed by the purchase of replacement property for a net $900,000. Your settlement statements would reflect this shortfall between sale and purchase, which typically results from taking on less indebtedness for the replacement property. This creates two aspects of the exchange: the $900,000 exchange portion and the taxable shortfall of $100,000.

Tax Consequences of a Partial 1031 Exchange

In the previous examples, you’ll be unable to defer the $100,000 cash out/reinvestment shortfall from taxation. That portion not reinvested is subject to capital gains and depreciation recapture taxes. The significance is that the IRS considers the first dollar out of the exchange profit. This means that regardless of your basis in the property, the first dollar you touch or the first dollar of the shortfall is taxable. The intent of a 1031 exchange is to defer, not forgive, taxes.

As such, any amount removed from the deferral process won’t escape taxation. Once you receive the cash out of the transaction or fail to meet the reinvestment target, it constitutes a taxable event.

Determine If A Partial Exchange Is Right For You

Depending on your situation, a partial exchange may be a good fit. Remember that the same 1031 exchange rules and restrictions apply if you complete a partial exchange. To discover it is right for you, join one of our upcoming webinars on partial exchanges or book a free consultation with an exchange expert.

This article first appeared on The Bigger Pockets blog on August 27, 2022.

How To Consolidated Into Multifamily Without Paying Taxes

October 22, 2021

Wondering how to transition into multifamily? While you may know that 1031 Exchanges let you defer capital gains taxes and depreciation recapture when you move from one property to another – did you know that you can use this same strategy to consolidate multiple smaller property sales into one larger one without paying taxes?

Owning quite a few smaller properties can leave you spread over a large area trying to maintain multiple locations. What if you could exchange all of those properties for one large multifamily unit without sacrificing any of your gain to Uncle Sam? The good news is, with consolidation 1031 exchanges, you can!

What is a Consolidation 1031 Exchange?

To put it simply, a consolidation 1031 exchange starts with the sale of investment real estate and ends with the purchase of investment real estate. As long as the property valuations work out, consolidation 1031 exchanges allow you to sell multiple units and combine their value into a larger purchase.

For example, if you have four single-family homes selling for $250,000 each, they could be sold and combined to purchase a property worth $1 million. This does require additional planning as the timing of your sales and replacement purchase must fall within the IRS mandated time frames. Coordinating extended and/or rapid closings with your purchasers and entering into a contract on your replacement property may require extra effort and negotiation.

Why do I need a Consolidation Exchange?

One of the main benefits of using a consolidation 1031 exchange is the deferment of taxes. Typically, when you sell your investment property, any gain is subject to taxation. Also, whether or not you took advantage of the available depreciation deductions while you owned the property, you will still be subject to “depreciation recapture” taxes. However, this is not the case when using a 1031 exchange.

Consolidation 1031 Exchange Example

Some clients of mine recently completed a consolidation 1031 exchange. They sold three properties in the Midwest and replaced them with one higher value vacation rental property in California. First, they identified both their replacement property. Then, they found a purchaser for all three of their original rentals. Then they sold the three original rentals over the course of three weeks. They purchased their replacement property just three weeks later. Not all transactions will happen as neatly or swiftly as theirs, but it is an indication of what advance planning can accomplish.

Consolidation Can Add Up

When you use a consolidation 1031 exchange, you can sell your investment real estate and purchase replacement investment real estate while indefinitely deferring payment of the tax that would normally be due on the sale. This can significantly increase your buying power as well as your opportunities for compound growth and reinvestment.

Click here to see our video training on consolidation exchanges.

Equal or Up Rule: 1031 Exchange Series Part Seven

July 26, 2020

In the final article of our seven-part series on the basic requirements of a 1031 Exchange, we will be discussing the last requirement; reinvestment of cash, also known as the Equal or Up Rule. While it’s the last stretch and you’re almost home free with tax deferment, the final requirement is just as important, if not more so, than the rest. Here we will explain exactly how the reinvestment of cash works and what the Equal or Up Rule is. If you follow along with the series, and this last requirement, you’ll be on your way to a successful 1031 Exchange!

Reinvestment of Cash / Equal or Up Rule

In order to defer all capital gains tax with a 1031 Exchange, you must put all of the cash proceeds from the sale into the next purchase. There is a way to do what is referred to as a partial exchange but we’ll cover that more further below. If the goal is to defer all tax, then all of the cash must be used toward the next purchase. If you touch any of that cash, it becomes taxable. Reinvestment of the cash isn’t the only thing you have to worry about though. You must also keep in mind the Equal or Up Rule.

The Equal or Up Rule refers to the fact that your new property purchase must be equal to or greater than the value of the property you sold (the net sales price once you pay commissions and closing costs). If you buy down, or purchase a property that costs less, it is considered to be the same as taking a profit. If you take a profit, then you won’t be able to defer all of the capital gains taxes and will have a taxable event.

The easiest way to calculate your reinvestment goal is to look at the bottom of your settlement statement. You’ll see the cash you received at the end of the sale, plus the amount of mortgage paid off. Those two numbers added together are your reinvestment goal. To make it simple just keep in mind that:

CASH + MORTGAGE PAY OFF = REINVESTMENT GOAL.

Partial Exchange and Taking Cash Out

When completing a 1031 Exchange, there may come a time where you need to take some cash out. If you need cash now, it is possible to do this and still complete your exchange. Remember, the reinvestment of cash requirement states that in order to defer all tax, you must use all of the cash and purchase at least as much as you sell. Therefore, taking some cash out or purchasing for less than what you sell does not jeopardize your exchange. However, it does create a taxable event. If you purchase less than what you sold or take some cash out, the IRS considers this to be “boot” and tax it as profit (don’t ask where the term boot came from…).

Some have asked about refinancing the property before selling and I don’t recommend it. The IRS does not look kindly upon refinances immediately before a sale. Though what you can do is start a 1031 Exchange, leave all of the proceeds in, complete the exchange and then immediately refinance the new property. This is considered borrowing against equity. If you leave all of the proceeds in, then refinance after the fact, you can get the cash you need and it will be tax-free.

Equal or Up Rule Summary

As you have learned by now, the IRS has very specific rules and requirements that you must follow for a 1031 Exchange. The Equal or Up Rule or the reinvestment of cash is straightforward and easy to follow. It simply means that the purchase of your new property must be equal to or greater than the property sold. The reinvestment amount is your net sales price. This is the contract price minus the closing costs of the net sale but before the mortgage is paid off. As long as cash is reinvested, all capital gains taxes will be deferred.

If you need cash right away, you can purchase a property for less than what you sold for. This is called a partial exchange. The amount you take out or buy down is taxed as profit while the rest remains tax-deferred in the exchange. It is also possible to refinance the property after you have started a 1031 Exchange. With this method, you leave all of the proceeds in and then pull tax free equity out of the new property by refinancing.

If you have any questions at all about any of these requirements, contact me and my team at 850-889-1031. We’re happy to help with any questions you have regarding your 1031 Exchange.

Article originally published at: https://www.biggerpockets.com/member-blogs/12255/91279-equal-or-up-rule-1031-exchange-series-part-seven

Title Requirements: 1031 Exchange Series Part Six

July 15, 2020

Welcome back to our seven-part series on the basic requirements of a 1031 Exchange! In our last article, we discussed the need for the Qualified Intermediary during the exchange. In this, part six, we are going to move on to title requirements. As we’ve now learned, the IRS is very detailed when it comes to the rules and regulations of a 1031 Exchange. Part of those regulations include very specific title and taxpayer requirements. Now we are going to discuss what those requirements are and the best way to avoid any title issues during the exchange.

Title Requirements in a 1031 Exchange

While there might be a lot of complicated statutes to understand during a 1031 Exchange, the title requirements are relatively straightforward. This requirement states that in the same manner the taxpayer holds title to the old property that is how the taxpayer must take title to the new property. Essentially this means that the taxpayer of the old property has to be the taxpayer of the new property. Therefore, if you are the taxpayer for a piece of property and sell it through a 1031 Exchange, then you must also be the buyer of the new property to qualify for the tax deferral.

Any tax paying person or entity that owns real estate is able to do a 1031 Exchange. That means you, as an individual, as well as any corporation, LLC, partnership, or trust could do an exchange. However, that doesn’t mean that an individual can complete a 1031 Exchange on property that is owned by an organization. The basic rule of thumb here is to check the tax returns. The name on the property and tax return will usually match. But the most important consideration is whose tax returns report the activity of the property.

Avoiding Title Requirement Issues

In a 1031 Exchange, title requirements are met when the taxpayer who owned the old property is also the taxpayer on the new property. We have also been asked if people should be added to the title before a sale. The answer to that is no. For example, Sue owns a rental property and she is currently the only one on the title. She may want to add another individual to the title right before she sells it. This is not recommended. By doing this another taxpayer has been added to the property. The IRS could then come around and ask why this person took title to the property. Did they take it to hold it for productive use? Or did they take title to primarily facilitate the sale? These are small details that could jeopardize a 1031 Exchange if they are not sorted out properly.

But this also illustrates another facet of the consistent taxpayer. What if that individual that the person above wanted to add to the deed happened to be her husband? If they file a joint tax return then the IRS actually perceives both of them to be the same taxpayer by virtue of the joint tax return. In that event adding her husband to the deed right before sale does not change the taxpayer and would be permissible.

As we mentioned above, entities such as corporations and an LLC can own real estate. While there are many different people involved in this process, the title requirements state that the taxpayer names must match. Therefore, you as an individual cannot complete a 1031 Exchange with property that is owned by another entity, even if you are a part of that entity. Your best bet is to always check the tax returns to be sure.

Do You Have Questions? We have Answers!

While the title requirements in a 1031 Exchange seem simple enough, we’ve seen clients accidentally trip over this step more than once. Always make sure you check the title and the tax returns to be sure. The taxpayer of the old property has to be the taxpayer of the new property. And it’s not as simple as simply matching the deeds. There are going to also be lending issues and certain state tax issues that can get in the way and trip you up if you don’t have an experienced guide as a QI.

If you have any questions at all about these requirements, contact me and my team at 850-889-1031. We’re here to help with any questions you have regarding your 1031 Exchange.

In the next and last part of our series on the basic requirements of a 1031 Exchange, we will be discussing the reinvestment of cash or the equal or up rule. This is a very important last requirement, so don’t miss out!

This article first appeared on the BiggerPockets website: https://www.biggerpockets.com/member-blogs/12255/91178-title-requirements-1031-exchange-series-part-six

Qualified Intermediary Requirements: 1031 Exchange Series Part Five

July 9, 2020

If you’ve been following along with our seven-part series on 1031 Exchange basics, you know that we’ve already covered the first three of the six basic requirements. Now, we are moving on to the fourth requirement, using a Qualified Intermediary. The IRS requires the process of a 1031 Exchange to be documented and managed by the Qualified Intermediary. In this article we will discuss the requirements for a Qualified Intermediary (QI). Both their role in the exchange process and what to look for your QI.

1031 Exchanges Require a Qualified Intermediary

The IRS has a strict set of rules and time limits that you must stick to in order to qualify for a 1031 Exchange. Using a Qualified Intermediary to document all the transactions of your exchange and hold your proceeds is part of those rules. The IRS code states that an unrelated third party must document and manage just the 1031 Exchange part of the transaction. During the exchange process, you will use the services of your usual and familiar real estate professionals. This may include a real estate attorney, a title company, an accountant for tax reporting, and probably several real estate agents. A Qualified Intermediary is simply another professional that is added during a 1031 Exchange. In addition to their mandated role, a good QI will also act as your guide through the process.

Something important to note here is that the Qualified Intermediary MUST be involved before the closing of the sale of your investment property. A 1031 Exchange starts with the sale of a piece of investment real estate and ends with the purchase of replacement property. But this only works if your Qualified Intermediary is in place prior to the sale.

Who Can Be Your Qualified Intermediary?

The Qualified Intermediary is an unrelated third party. While we have mentioned a “third party” before, it’s important to emphasize that the Qualified Intermediary must truly be a third party. It cannot be your attorney, real estate agent, husband, or wife, etc. It has to be a completely unrelated party where all they do for you is document and manage your 1031 Exchange.

While the statue isn’t completely clear on what “qualified” is, it is crystal clear on what disqualifies someone from this role. That is: if there’s an agency relationship, a business relationship or a family relationship, the person or entity would be disqualified. This essentially means that as long as you haven’t purchased used tires from the used tire shop down the road, they could technically act as the Qualified Intermediary. However, that’s clearly not in your best interest. To understand why, let’s take a look at exactly what the Qualified Intermediary does.

What does the Qualified Intermediary Do?

The Qualified Intermediary will work alongside you and the rest of your regular professionals to document the entire 1031 Exchange and hold the proceeds from your sale. At a minimum, this includes:

Creating an exchange agreement (between QI and the investor)
Providing the assignment of contract rights (signed by the investor and enacted by the title company)
Giving notification (all parties to the transaction have to be notified – no standard of when)
Receiving and maintaining sale proceeds during the transition into the new investment/until the end of the exchange

Let’s take a closer look at these official aspects of the QI’s role.

EXCHANGE AGREEMENT

There will need to be an exchange agreement between you and your Qualified Intermediary that lays out all of the requirements we discuss in this article series. This agreement will specify what your role is going to be, what you’re going to have to do to finish the exchange, and what the Qualified Intermediary is going to do for you. This exchange agreement will be your contract with them.

ASSIGNMENT OF RIGHTS

As part of the process of using the Qualified Intermediary, there must be an assignment of rights. This is where you assign your rights to the sell the property to your Qualified Intermediary. Many states and jurisdictions already have real estate contracts that have check the boxes or default cooperation addendums for a 1031 Exchange. If that is not the case with your contract, we recommend you simply make your contracts assignable if possible. Regardless, this assignability and the exchange documents prepared by your QI allow the title company to direct deed the properties from the exchanger to the buyer and from the seller to the exchanger.

Note that your QI should never take title to either the relinquished or replacement properties. The QI is the assignee only on the settlement statement. This is an aspect of the assignment of rights that should be discussed in your Qualified Intermediary selection process (see more below).

NOTIFICATION

The statute does not specify how or when the parties to the exchange must be notified, only that it is required. Some exchangers have experienced more aggressive bargaining situations when the seller realizes a 1031 Exchange is in process. As a result, most QIs opt to provide this required notice as part of the closing process.

RECEIPT AND MAINTENANCE OF PROCEEDS

For an exchange to be valid, the investor may not have actual or constructive receipt of the proceeds from the sale of their relinquished property. Remember how we said before that you must have the Qualified Intermediary before you close the sale of your investment property? Part of the reason why is that after the closing of the sale, your proceeds must go into an exchange account with the Qualified Intermediary. The IRS considers funds in escrow with the title company constructive receipt by the seller, so the funds must be transferred to the QI. Then, when you purchase your replacement property, the funds will be transferred by the QI directly to the title company for closing.

Finding and Hiring the Right Qualified Intermediary

As your QI has to be an unrelated third party and will be holding significant cash on your behalf, we recommend you look for someone that meets these five criteria:

Uses dual signatory segregated, qualified escrow accounts for your exchange funds (at no charge).
Guarantees their exchange documentation.
Provides support and documentation in the case of an IRS audit (at no charge).
Is easily accessible to answer questions (at no charge).
Has extensive, verifiable experience and a solid reputation.

While the exchange fee charged is a consideration, there is a range and a variety of potential additional charges among QIs who meet the above criteria. We recommend you check out our previous article on how much an exchange should cost to see what you should be paying and what your fee covers.

Don’t miss the next part of our series on the 1031 Exchange basics, when we’ll be talking about all of the necessary title requirements.

Originally posted on The Bigger Pockets Member Blog.

180-Day Rule: 1031 Exchange Series Part Four

July 3, 2020

So far in our seven-part series on 1031 exchange basics, we have discussed the six basic requirements, property being held for investment, and the 45-day identification rule. In the fourth part of our series, we are going to discuss more in depth the third requirement for a 1031 exchange which is the 180-day rule. If you’re curious about what this rule is and the timing requirements behind it, continue reading on to learn more.

The 180-Day Rule

As we have discussed in previous articles, there are two critical timing requirements when completing a 1031 exchange. This first is the 45-day identification rule which we discussed in part three of this series. The second is the topic we are discussing now, the 180-day rule. The 180-day exchange period runs concurrently with the 45-day identification rule. Therefore, if you haven’t read that part yet, we highly recommend it. However, here is a brief summary:

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Day one of the 45-day identification period starts on the day of your closing. You have 45 calendar days from the day of your closing to identify the replacement properties and take title to it OR produce a written list of the replacement properties that you’re going to use.

Similarly, the 180-day rule also starts on the day that you close your property. As we also mentioned, it runs concurrently with the 45-day identification rule. What this means is you have a total of 180 days to complete the entire 1031 Exchange transaction. While you may have 45 days to identify properties, you have a total of 180 days to close on the new property and accept the title to it. It’s important to note that the property you choose must be one of the properties from your 45-day list.

You Must Choose a Property from Your 45-Day List

One of the requirements of the 180-day rule is that you must choose a property from the45-day list you have turned in. This is a Federal IRS rule and there are no exceptions and no extensions. 180 days to complete an exchange sounds like a long time. It is the 45-day period is where most people get lost or fall behind. It is imperative you start looking for replacement properties as soon as possible and make a list of potential properties. In the end, when the 45 days are up, you are left to choose from that list and that list only. You will then have to close on one of those properties within the 180-day window.

You May Have Less than 180 Days

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If you’ve ever read over any federal laws, you know that they are very complicated and nuanced. Unfortunately, there is no exception here. With the 180-day rule, you actually have the lesser of 180-days or to the date of your next tax filing. The reason for this is the IRS wants your 1031 Exchange wrapped up and completed before you file your taxes. Therefore, it has to be reported on your next tax return.

For example, as everyone knows Tax Day is April 15th. If you sold your relinquished property on December 15th, you would have until April 15th to completely wrap and finish your 1031 Exchange by purchasing your replacement property or properties. This could be significantly less time than the allowable 180 days. You can easily avoid this by filing for an extension on your taxes. But, it’s a very important aspect to keep in mind. If you know you aren’t going to be able to complete your 1031 Exchange before taxes are due, go ahead and file for an extension.

Timing is Everything with the 180-Day Rule

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In the last two articles, we’ve discussed a lot about timing. The reason for this is because timing is everything in a 1031 Exchange. Properties must be identified within 45 days and you then have 180 days to close on one or more of those properties, and only those properties. However, keep in mind that you may actually have less than 180 days if you are due to file your taxes before then. If that is the case, you may want to request an extension on your taxes so you have time to finish your 1031 Exchange.

This article was originally posted at https://www.biggerpockets.com/member-blogs/12255/91039-180-day-rule-1031-exchange-series-part-four.

45-Day Identification Rule: 1031 Exchange Series Part Three

June 23, 2020

If you’ve been following along with our seven-part series on 1031 exchange basics, you’ve already learned about the six basic requirements. We’ve already discussed the requirement of the property being held for investment in part two. Now, in part three, we will discuss the second requirement of a 1031 exchange which is the 45-day identification rule. Continue reading on to understand what the rule is and why it’s important.

The 45-Day Identification Rule

There are two very critical timing requirements when completing a 1031 exchange. This first is the 45-day identification rule and the second is the 180-day rule, which we will discuss in part four of this series. The 45-day identification rule is relatively straightforward. This states that you have 45 days from the date of closing your sale in order to identify your potential replacement properties. Before you begin to panic, this doesn’t mean closing on them or getting them under contract. It simply calls for you to identify them.

While 45 days seems like a lot of time before you sell, once people close, they tend to go into panic mode. Don’t let this happen to you! Our best recommendation is to start the search for your replacement property well before you close your sale. It’s important to note that day one starts on the date of your closing. You then have to the end of 45 calendar days to do one of two things:

Identify the replacement properties and take title to it OR
Produce a written list of the replacement properties that you’re going to use

If you decide to go with the second of the two options, you must actually write the list and it needs to be a specific identification. For example, you can’t just write down, “I want to buy a unit in the Carrollwood condos”. Rather, you’ll need to be more specific by saying, “I want to buy (or I’m thinking of buying) 4352 Unit C in the Carrollwood condominiums”.

Narrowing Down the List

The list of potential properties you need to create within 45 days is very important. Therefore, it’s critical that you get on top of it right away. Only the property that is on that list will qualify to finish your 1031 exchange. Now, your first thought might be to just load up your list with twenty or thirty properties. It makes sense but the IRS has anticipated this and placed limits upon it. The IRS creates a sort of three-part funnel where they try to make you be very specific and limit the number of properties that you identify for your exchange. This part can get a little tricky, so we’re going to break it down further.

First Part of the 45-Day Identification Rule

The first part of the 45-day identification rule states that as long as you name three or fewer properties in your list, it doesn’t matter how much they’re worth. For instance, if you sell a small condo for $100,000, you could name three $5 million-dollar offices on your list and it would be fine. Of course, you might have a little trouble closing on those if all you’re selling is a $100,000 condo. However, you are still able to do it.

Second Part of the 45-Day Identification Rule

Now, the second part of the 45-day identification rule covers what happens when you list more than three properties. In this situation, the total value of that list can be no more than 200% of the value of what you sold. If we go back to our last example with the $100,000 condo, you would be able to list four replacement properties worth $50,000 each. That’s because $50,000 x 4 = $200,000 which is 200% of the original sale of $100,000. You cannot go over this limit. If you tried to list three of those $50,000 properties and then a $75,000 one, you would be over the limit and it would disqualify your entire exchange.

In order to make this just a bit more confusing, there is one more exception to listing more than three properties. If those four or more properties have to be more than 200% of the value of what you sold, you can still do it; but only if you actually closed on 95% of the value of your list. This is the trickiest part of IRS law and can be perplexing to try and understand, even for professionals.

If we go back to our example of selling a condo for $100,000 and listing four replacement properties. Consider if on this list there are three $50,000 lots and one $75,000 lot. So, more than three are named and the total of the four is more than 200% of what you sold. HOWEVER, if you closed on all four of those lots, then you would have closed on 95% of the value of the list. Therefore, you are able to do that.

There are No Extensions and No Exceptions

It’s in your best interest to keep this process simple and quick. 45 days can go by very quickly and the IRS does not offer any individual extensions or exceptions. Once the 45 days have passed, whatever is on that list are the only properties you can choose from. It doesn’t matter if you get outbid on one, another burns down, and the owner of the other one dies and it goes into probate, those are the properties the IRS says you can purchase. There are no individual extensions and no exceptions. This is where most 1031 exchanges usually fail, therefore it’s important to take it seriously.

We’ll offer one last example to make sure you completely understand the 45-day identification rule.

Billy and Jane have sold their rental property for $100,000. They want to identify two or three $1,000,000 replacements. Can they do that? The answer is yes because they only named three or fewer potential properties.

However, what if Bill and Jane sell that same property for $100,000 and they want to identify four little condos for $75,000 each. Can they do that? Well, the answer is maybe. Although it does break the 200% rule, as long as they closed on all four of those, they would have closed on 95% of the list. Therefore, that would qualify under the IRS 45-day requirements.

The best advice we can offer is to start looking for properties before you close. Don’t take too long to get started. We offer a convenient 1031 Exchange Timeline Calculator that will help you with the 45-day identification rule as well as the upcoming 180-day rule. We highly recommend you bookmark this page and use it whenever you’re planning your 1031 exchange.

First published on BiggerPockets at: https://www.biggerpockets.com/member-blogs/12255-dave-foster-the-1031-investor/90936-45-day-identification-rule-1031-exchange-series-part-three