180-Day Rule: 1031 Exchange Series Part Four

So far in our seven-part series on 1031 exchange basics, we have discussed the six basic requirementsproperty 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

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.

Held for Investment: 1031 Exchange Series Part Two

In the first part of our seven-part series on 1031 exchange basics, we discussed the six basic requirements. The first of those six requirements state that the real estate must be held for investment. In this, the second part of our series, we will discuss what held for investment means, what property qualifies, and how the holding period can be determined.

Held for Investment

This requirement states that in order to qualify for a 1031 exchange, the real estate must be held for investment. It’s vital to remember that this is different from section 121, which refers to your primary residence. With a 1031 exchange, we’re discussing investment real estate. That means we’re not concerned with the type of property as much as the use of it. Overall, the use of the real estate is what’s most important.

There are three different types of uses that qualify under the held for investment rule. This includes uses for trade, business, or investment. You can read more about each of them below.

  • Trade
    This means that you are holding the real estate for productive use in trade. For example, this could be a factory where you store or produce clothing if you’re a retail designer. If you work as a plumber, this could be a building where you keep items that you need for your trade such as toilets or pipes.
  • Business
  • Holding real estate for business purposes covers properties that you generate income off of. This may be an apartment complex that you rent out to tenants. It could also be a shopping center where you lease out space to businesses.
  • Investment
    The final use that qualifies under the held for investment requirement is holding the property for investment purposes. This means you’re trying to garner the incremental increase in value as it relates to a factor over time. To put it simply, you bought the real estate to hold it while it appreciates or increases in value over time.

Investment versus Inventory

Most of us don’t think of real estate as inventory. But, this is an important concept to understand when dealing with IRS rules and regulations regarding 1031 exchanges.

While we spoke about investment property above, it’s important to note the mention of appreciation as an increase in value over time. This is a critical factor in separating investment from inventory.

You cannot purchase a property for $50,000, fix it up, and promptly sell it for $100,000 and defer the tax with a 1031 exchange. In this case, the IRS considers such flipped property as inventory. Since you purchased it with the intent to simply turn around and resell it at a profit, it does not qualify for a 1031 exchange.

However, if you purchased the property at $100,000, fair market value, and a few years later it’s worth $200,000, that is appreciation. By holding the property and allowing it to appreciate in value, it is considered investment real estate.

The first scenario does not qualify for a 1031 exchange but the second one does.

Property That Does Qualify

A 1031 exchange covers U.S. property for U.S. property with a few exceptions. These exceptions include the U.S. territories of Guam, American Samoa, and the U.S. Virgin Islands. For example, you could sell a property in the U.S. and buy a property in St. Thomas (in the U.S. Virgin Islands) and do a 1031 exchange. Even though Puerto Rico is a U.S. territory, you are unable to do an exchange between a U.S. property and one in Puerto Rico due to the way their commonwealth is setup. You are able to sell foreign real estate and buy foreign real estate using a 1031 exchange. However, if it is a U.S. property, only other U.S. properties or ones from Guam, American Samoa, and the U.S. Virgin Islands will qualify.

As a general rule of thumb, rental properties will always qualify since you are holding them to generate income. Raw land is also always an investment. This is because you’re investing in raw land, not because you expect to turn it for a quick profit. If it does happen to appreciate quickly, it’s up to you and your accountant to decide what the intent was when you bought it.

Examples of Held for Investment Exchanges

To understand this a little better, let’s look at an example. Let’s say you purchased a piece of raw land at an auction. Then, three months later, you are able to sell that land for three times the amount you bought it for. Would this qualify for a 1031 Exchange?

That depends. When you bought the land, did you know it was going to be worth that much more immediately? Did you buy the land primarily to resell it? If you answer yes to those questions, you would be flipping the land and therefore not eligible for a 1031 exchange.

But what if, as one of my clients experienced, you never put the land up for sale? What if you had already planted crops? Then, what if someone approached you and offered to buy the land? In this situation, my client clearly intended to hold the land for productive use. But then the local gas company identified his land as the perfect place for a distribution hub and made him an offer he couldn’t refuse. In this instance, he clearly intended to hold it for productive use so even though his intent changed and he sold it quickly, it still qualified for a 1031 exchange.

Another example would be if you owned a duplex that you bought a while back. Let’s say you now want to sell and go buy a vacation condo on the beach. You’re going to use the beach condo a little bit but you also want to rent it out. Can you do a 1031 exchange in this situation? Absolutely! This still qualifies as rental property that you intend to hold. Personal use does not disqualify it, although there are some IRS rules and regulations about that, too (https://www.biggerpockets.com/blog/vacation-home-1031-exchange).

Intent is Key for the Hold Period

Typically, the hold period that most investors use for 1031 exchanges is longer than twelve months. Now, there’s no magic to that, because there is no statutory holding period. In the past, if you held property for more than twelve months, you would automatically qualify that property as a capital gain “long term”. If this property was sold with less than a year’s ownership, you would pay ordinary income. However, that easier measure is no longer valid and it is very difficult to put a time period down now.

My best advice is that longer is better rather than shorter. This is because the keyword to the entire statue revolves around the single word of “intent”. You are going to sell property that it has been your intent to hold for productive use in trade, business, or investment. However, now you’re going to purchase a new property that you intend to hold for productive use in trade, business, or investment. That’s the basics of a 1031 Exchange.

In summary, there are two ways to demonstrate your intent to hold for investment as there is no statutory holding period. The first way is that longer is always better than shorter. The second way revolves around your past history. What have you’ve always done? Do you have a history of buying property and holding onto it and renting it? Then you’ve set up something to demonstrate what your intent is. And your established intent is key when satisfying the requirement that the property being exchanged for investment.

This article originally posted at: https://www.biggerpockets.com/member-blogs/12255/90843-held-for-investment-1031-exchange-series-part-two.

The Six Basic Requirements of a 1031 Exchange

When you’re looking to keep your taxes working for your own benefit with a 1031 exchange, it’s important to understand the requirements that need to be met. There are six basic requirements of a 1031 exchange. All six of these must be met in order for a 1031 exchange to be successful. In the first part of our seven-part blog series on 1031 exchange basics, I’ll go over the six basic requirements.

The Six Basic Requirements of a 1031 Exchange

  1. Held for Investment
  2. 45 Day Identification Rule
  3. 180 Day Rule
  4. Qualified Intermediary Requirements
  5. Title Requirements
  6. Reinvestment of Cash / Equal or Up Rule

I can’t stress enough that all six requirements need to be met. Even if you meet five of the six, the 1031 exchange will still fail. This type of exchange is authorized in the tax code and overseen by the internal revenue service (IRS). While they do have to allow exchanges and follow their code, they don’t have to make it easy. That’s why it’s important to make sure you understand and have a plan in place to meet all six basic requirements of a 1031 exchange before you proceed.

Within the six requirements, you’ll find that there is a requirement for the type of real estate. You’ll also have to follow certain timing rules such as the 45-day rule and the 180-day rule. There is a requirement for the use of a qualified intermediary to assist in the exchange. There are also special requirements surrounding the title as well which include how the title must be held. Finally, you’ll have to make sure you meet the reinvestment requirements. This specifically deals with what you have to put back in, or reinvest, to make sure that you will get the full amount of tax deferral.

In this seven-part blog series on 1031 exchange basics, I’ll cover all of the six requirements. This includes what they are, how they work, and what you need to do in order to achieve a successful 1031 exchange.You can also find this information via the Video Training link at www.the1031investor.com.

This article first appeared on my Bigger Pockets member blog.

There are more ways to control your money than just receiving cash. Even funds held in escrow by your title company are considered yours and can constitute constructive receipt.

Constructive Receipt and 1031 Exchanges

Protect Your 1031 Exchange – File for an Extension

If your 1031 exchange began in late 2019, you may need to file for an extension of your tax deadline. This is because the normal exchange period of 180 days will be shortened to your tax filing day (April 15th with out an extension) if your surrendered property closed between October 19th and December 31st, 2019. Therefore, it is important to remember to file for an extension in order to protect your complete 180-day 1031 exchange period.

Why does this happen? The regulations outlined in Section 1031 state, “The exchange period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) for the taxpayer’s return of tax imposed by chapter 1 of subtitle A of the Code for the taxable year in which the transfer of the relinquished property occurs.”

To explain this a little better, your normal 180-day exchange period can be reduced if you began your 1031 exchange after October 19th, 2019. If you are unable to purchase a like-kind replacement property before the deadline of April 15th, you should consider filing a tax extension in order to allow yourself the full 180 days.

How this Works

For example, Mr. Jones sells Vista Apartment Complex as part of a 1031 Exchange on November 26, 2019. Although the 180th day after this sale of his relinquished property is May 24, 2020 – his tax filing deadline occurs before this and automatically becomes his 1031 Exchange deadline as well. By filing an extension to his tax return, Mr. Jones can extend both his tax filing deadline and revert his 1031 Exchange deadline to the full 180-day exchange period.

Therefore, if your relinquished property closed between October 19th and December 31st, 2019, it’s important to file for an extension on or by April 15th, 2020. This will ensure you don’t lose out on your full 180-day 1031 exchange period.

Resources

To determine if the exchange you initiated in 2019 has a 180 day deadline after April 15th, use my 1031 exchange deadline calculator at The 1031 Investor.

To get more information about how to file for an extension, check out the IRS website for complete instructions.

A Consolidation 1031 Exchange and Why You Need It

If you have several different investment properties, it may be beneficial for you to sell them and invest in a larger property with a consolidation 1031 exchange. If you have been focusing on single family rentals, for example, you may own quite a few smaller properties. But, this 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 unit such as an office building? 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.

Airbnb and 1031 Exchanges

1031 Exchanges and Conversion Into a Primary Residence

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.

 

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

https://www.biggerpockets.com/blog/closing-costs-1031-exchanges

Bigger Pockets blog

Wondering what closing costs can be included in your 1031 Exchange? Check out our latest article on the Bigger Pockets blog.