TYPES OF SECTION 1031 EXCHANGES
- Delayed Exchange: A delayed exchange occurs when the relinquished property is sold first and replacement property is subsequently acquired. I.R.S. regulations generally require the use of a Qualified Intermediary (‘QI’) for delayed exchanges.
- Reverse Exchange: A reverse exchange occurs when a taxpayer must acquire the replacement property prior to closing the sale of the relinquished property
- Improvement Exchange: An improvement exchange occurs when improvements are to be constructed on a replacement property.
IMPORTANT RESTRICTIONS AND CONSIDERATIONS FOR DELAYED EXCHANGES
When a taxpayer determines that a Section 1031 tax-deferred exchange is appropriate for their situation, IPE 1031 will coordinate the transaction and provide specific step-by-step instructions and documentation regarding the following important considerations. The following rules detail only very basic restrictions and considerations of which exchanging taxpayers should be aware.
- The 45-Day Identification Time Limitation: After the taxpayer sells the original relinquished property(ies), two very important time limitations come into play. The limitations are classified as the 45-day identification period and the 180-day exchange period. There are no exceptions or extensions. Should these time periods be violated, the exchange will fail.
- The 45-day exchange period starts after the sale of the original relinquished property. After the closing on the relinquished property, you have 45-days to identify the replacement property(ies). In the case of an exchange involving multiple relinquished properties, the 45-day exchange period begins upon the sale of the first relinquished property.
- Property Identification Rules: You may identify as many as three replacement properties, regardless of their total value (the “3-Property Rule”), or you may identify any number of properties provided their aggregate fair market value on the 45th day does not exceed 200% of the aggregate fair market value of all of your relinquished property on the date of its transfer (the “200% Rule”). If you stay within these rules, you do not need to acquire all of the property identified. A third rule applies to situations where the taxpayer cannot comply with the 3-Property or 200% Rules. Further details on this rule can be provided upon request.
- The 180-Day Exchange Period: After proper identification of the replacement properties, closing must be completed by the earlier of:
(a) 180 days following transfer of your relinquished property; or in the event of multiple relinquished properties, 180 days following the transfer of the first relinquished property; or
(b) The due date for your federal income tax return for the year in which your property was relinquished. 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.
- Avoiding All Taxable Gain: As a general rule, exchanging taxpayers should keep three important considerations in mind. First, replacement property fair market value must be equal or greater than the fair market value of the relinquished property. Second, all of the exchange proceeds from the sale of the relinquished property must be used to acquire the replacement party. Third, the replacement property debt must be equal to or greater than the relinquished property debt so as to avoid taxable gain due to debt relief. Not following these rules may result in taxable gain. These three considerations are mentioned to help exchanging taxpayers structure a Section 1031 exchange. If you do not follow them, you may still do the exchange. However, it is extremely important to speak with your tax advisor regarding the effects of debt relief or receiving cash for personal use.
MORE INFORMATION ABOUT REVERSE AND IMPROVEMENT EXCHANGES
- Exchange Accommodation Titleholder: An exchange accommodation titleholder (‘EAT’) is typically involved with reverse and improvement exchanges.
- Exchanging taxpayers may be unable to sell relinquished property prior to acquiring replacement property or may have specific reasons to acquire replacement property prior to the sale of the relinquished property. It may additionally be the desire of an exchanger to construct improvements on a property prior to its acquisition. For these circumstances, the I.R.S. created a “safe harbor” with Rev. Revenue Procedure. 2000-37 authorizing the execution of “reverse” and “improvement” exchanges.
- Under this I.R.S. safe-harbor, exchangers are prohibited from taking actual title to the replacement property prior to the sale of relinquished property. As a result, an EAT must step in the shoes of the exchanger. Careful attention must be paid by the exchanger to ensure that proper arrangements are made prior to the sale. As with a delayed exchange, specific restrictions and time limitations must be followed, including the requirement that an exchanger use a qualified intermediary to facilitate the exchange between the respective property owners and the EAT.
- Fees for reverse, build-to-suit, and improvement exchanges are substantially greater than for delayed exchanges due to the fact that I.R.S. rules require that the EAT actually own the “parked” property. Certain transactional costs are inherent to the transaction and include transfer taxes, recording fees, mortgage taxes, lender charges, escrow and title fees, legal and accounting fees, insurance fees, and the costs of creating a special purpose entity (SPE) to hold the parked property. Fees charged by IPE 1031 are based upon the level of complexity of a transaction.
- Reverse and improvement exchanges involve complex considerations and require extensive advanced planning. As a result, exchangers contemplating this course of action must provide IPE 1031 with sufficient lead time to structure the exchange