1031 Exchanges

three-party or "Starker" exchanges

(named for the first tax case that allowed them). In a delayed exchange, you need a Qualified Intermediary (middleman) who holds the cash after you "sell" your property and uses it to "buy" the replacement property for you. This three-party exchange is treated as a swap.

Buyer

The person acquiring the Exchangor's relinquished property.

Swapping Primary Home

1031 is only for investment and business properties so you can't swap for your primary residence

Qualified Intermediary

A non-disqualified party who handles the exchange transaction pursuant to section 1031 of the IRC.

Like-Kind Property

A tax term used in exchanges; property may be exchanged for like in kind property and the tax postponed (does not refer to the physical similarity of the properties).

Personal Property

Before passage of the new tax legislation on Dec. 22, 2017, some exchanges of personal property - such as franchise licenses, aircraft and equipment - qualified for a 1031 exchange. Under the new law, only real estate qualifies.

Advantage-Increased Cash Flow/Income

Cash flow and overall income can both be increased through a 1031 tax-deferred exchange. For example, a vacant parcel of land that generates no cash flow or depreciation benefits can be exchanged for a commercial building that does.

Boot

Cash or non-cash consideration, including any property that is not "like-kind," promissory notes, or debt relief (mortgage boot). If you receive boot in an exchange, it is likely that all or some portion of the boot will be taxed.

Growth Factor

Interest earned on the exchange proceeds while held by the Qualified Intermediary (QI).

Advantage-Leverage

Investors can take advantage of the 1031 tax-deferred exchange to acquire a more valuable investment property. By utilizing the money they would have paid to the IRS in taxes, they can increase their down payment and improve their overall buying power to acquire a more expensive replacement property. Thus, leveraging their cash and continuing to build wealth through real estate investment.

Advantage-Management Relief

Investors that own several rental properties are often faced with the burdens of intensive management and costly maintenance - which often leads to increased headaches! An investor can increase profits and decrease time and effort by exchanging out of high maintenance rental properties and consolidating into an apartment building or NNN leased investment.

Closing Costs

Miscellaneous expenses involved in closing a real estate transaction over and above the price of the land. For example: Brokers commissions, settlement fees, Qualified Intermediary (QI) fees , documentary transfer taxes, recording fees, legal fees.

Exchange Period

Once escrow closes on the relinquished property, the investor has the lesser of 180 days from the date of closing, or the date on which the investor's tax return for the year the relinquished property was sold is due, to close the purchase transaction and complete the exchange. For exchanges closing in the final quarter of the year, the taxpayer will need to get an extension to file his tax return to get the full 180 days.

Receipt of Cash

Once the sale of your property occurs, the intermediary will receive the cash. If you receive cash, it is taxed. You may have cash left over after the intermediary acquires the replacement property. If so, the intermediary will pay it to you at the end of the 180 days. That cash - known as "boot" - will be taxed as partial sales proceeds from the sale of your property, generally as a capital gain.

Constructive Receipt

Proceeds although not actually reduced to a taxpayer's possession are constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time.

Adjusted Basis

The cost of the property adjusted for any capital improvements or depreciation. Original cost of property + Improvements - depreciation = Adjusted Basis.

Tax Deferral

The feature of an investment in which taxes due on principal and/or earnings are postponed until funds are withdrawn, often at retirement.

Identification Period

The investor has 45 days from the closing of the relinquished property to identify replacement property. Proper identification of replacement property is a requirement for a valid exchange, and the investor can only acquire property which has been properly identified during the 45-day identification period.

Exchangor

The person who is trading his property for another.

Basis

The starting point for determining gain or loss in any transaction. In general, basis is the cost of the taxpayer's property. Transactions involving exchanges, gifts, probates, and receiving property from a trust can have an impact on calculating the property's adjusted basis.

Advantage-Consolidation/diversification

With the flexibility of an exchange, an investor may exchange one property for several others, consolidate multiple properties into one, and acquire property anywhere within the United States.

Treatment of Debt and Mortgage

You must consider mortgage loans or other debt on the property you relinquish, and any debt on the replacement property. If you don't receive cash back, but your liability goes down - that, too, will be treated as income to you, just like cash.

Depreciation Recapture

the cumulative amount of depreciation that has been taken since the property was placed into service This amount is generally taxed at the depreciation recapture tax rate when/if the property is sold

Delayed Exchange

- the property must be identified within 45 days and the exchange completed within 180 days of transfer of the exchanged property - Identification of the exchange property must meet 1 of 3 guidlines: 1. ID of up to 3 properties of any value w/ the intent to purchase one of them 2. ID of more than 3 properties as long as the combined market value doesn't exceed 200% of the market value of the property relinquished 3. ID of more than 3 properties with a combined market value exceeding 200% of the market value of the relinquished property but you must acquire 95% of the market value of all of the properties ID'd

Reverse Exchange

- the replacement property is acquired prior to the property owner giving up their property - an exchange accommodation titleholder takes title to the property the exchangor wishes to acquire and holds the title until the sale of the exchange property can be arranged - removes the problem of acquiring property w/in an amt of time - the sale must be within 180 days

simultaneous exchange

A tax-deferred exchange in which the closing for the relinquished and replacement property occur simultaneously or almost simultaneously

Safe Harbor

An IRS provision that gives a Taxpayer protection as long as the requirements to comply with the code are met.

Improvement Exchange

An improvement exchange, sometimes also called a construction exchange, is designed in such a way that proceeds from the relinquished property are able to be used to purchase replacement property that needs to be improved. When this happens, an intermediary will retain all ownership of the replacement property until construction is finished or excess proceeds are used up fully. At the end of this construction or improvement period, the intermediary transfers the ownership of the replacement property to the exchanger. The build-to-suit exchange allows an owner to use the proceeds from the sale of the relinquished property not only to acquire replacement property, but also to make improvements to the property.

Like-Kind Exchange

An investor can exchange real estate for real estate- an apartment house for an office building. Being a like-kind Exchange qualifies the sale as a tax deferred exchange. Any additional cash or personal property given with the property is considered boot and is taxable. an enigmatic phrase that doesn't mean what you think it means. You can exchange an apartment building for raw land, or a ranch for a strip mall. The rules are surprisingly liberal. You can even exchange one business for another.

Advantage-Increased Purchasing Power

Original Cost (Basis) $100,000 Plus Capital Improvements $20,000 Less Depreciation $35,000 Equals Adjusted Basis $85,000 Sales Price $500,000 Less Adjusted Basis $85,000 Less Costs of Sale $40,000 Equals Capital Gain $375,000 Funds available for reinvestment w/o exchange (not including state capital gains due) $383,250 Funds available for reinvestment w/1031 exchange $460,000

Vacation Homes

taxpayers can still turn vacation homes into rental properties and do 1031 exchanges. Example: You stop using your beach house, rent it out for six months or a year, and then exchange it for other real estate. If you get a tenant and conduct yourself in a businesslike way, you've probably converted the house to investment property, which should make your 1031 exchange OK.