Section 1031 Like Kind Exchanges

How much appreciation of my property is necessary to make a like kind exchange worthwhile? As a general rule, you should think about undertaking a 1031 exchange whenever your sale price exceeds your tax basis by ///25,000 or more (assuming you plan to spend at least that amount in acquiring the Replacement Property).

What kinds of properties can be exchanged? Any real estate can be exchanged for any other real estate--including vacant land for a house, or a house for a condo apartment, or vice versa--so long as both properties are held for investment purposes at the time of the exchange. Section 1031 regulations do not define "investment" property, but a house that is rented for the summer is more likely to qualify than one that sees mostly personal use. Vacant land is usually considered to be an investment because it has no value for personal use--unless, perhaps, you're buying it to build a personal residence.

Can I convert a personal residence to investment property and then exchange it? Yes--if you plan ahead. For example, you might be able to "convert" your vacation home to investment property by renting it before selling it. It's also possible to "convert" investment property to personal-use property after you acquire it.

What happens to the sale proceeds when I sell my property? Net sale proceeds will be held by an intermediary and used to acquire the Replacement Property, and during this period you have no access to the escrowed funds. You will be credited with any interest or dividends earned on the funds.

After I sell my property, how much time do I have to complete the exchange? You have 45 days from the closing to "identify" a Replacement Property and another 135 days (180 days from the first closing) to close on it. You can identify as many as three properties (in some cases more than three) during the 45-day period, but once this period has expired you must acquire one of the identified properties or lose the exchange. A property need not be put under contract to be identified; it is sufficient just to describe the property in a writing that's given to the intermediary.

Must I reinvest all the proceeds from the sale of my property? No--but you will pay taxes on the portion not reinvested (after deducting closing costs for both closings).

I'd like to exchange for a less expensive property (perhaps vacant land) and then immediately spend the difference to improve the new property. Will the cost of these improvements count as money reinvested and thus defer taxes? Improvements don't count if you take title to the property before you make them. What counts is the value of the Replacement Property when you close on it. You can get around this problem, however, by having the intermediary hold title during the construction period. This approach, although more complex than a basic exchange, is worth considering if the proposed improvements are extensive.

Can I reinvest my sale proceeds by buying more than one Replacement Property? You can, provided that your exchange is structured to allow multiple purchases. You can also have more than one Relinquished Property, but such an exchange is more complicated than a single-sale exchange.

Will a mortgage on the property I'm selling or buying affect my exchange? There are additional considerations to be made for an exchange involving a mortgage. For example, if you now have a mortgage on your property, to defer taxes completely you must reinvest the total amount of your sale proceeds without deduction for your mortgage payoff. One way to meet this requirement is to take out a mortgage on the Replacement Property. But be careful: Too large a mortgage will result in a capital gains tax.

Can I buy my Replacement Property before I sell my Relinquished Property? Yes, but a "reverse" exchange takes more effort than a "forward" exchange. A somewhat recent Revenue Procedure allows reverse exchanges to be made through an "exchange accommodation titleholder," an intermediary who typically buys your Replacement Property from a third-party seller and owns it until your Relinquished Property is sold to a third-party buyer. (A less common and more elaborate arrangement would involve having the intermediary buy your Relinquished Property and hold it until a third-party buyer is found.) Although the reverse exchange is complicated--especially when it involves bank financing of a property included in the exchange--it may be the only solution when you find your ideal Replacement Property before you find a buyer for your Relinquished Property.

Is it possible for a Relinquished or a Replacement Property to be part investment property and part personal-use property? Yes, you can exchange a property that is used for more than one purpose. When that happens, it may be appropriate for the sale or acquisition price to be allocated according to the use of the property. In this situation a good tax accountant will come in handy.

I have a residence that is held by a Qualified Personal Residence Trust and is rented during part of the year. Is it possible to make the sale of this house qualify for a 1031 exchange? Yes, under certain circumstances it can be done. Strange as it may seem, it is possible for property that qualifies as a personal residence for "QPRT" purposes also to qualify as investment property for 1031 purposes.

How much cooperation will I need from the buyer of my Relinquished Property and the seller of my Replacement Property? Very little, because the bulk of the paperwork involves only you and the intermediary. These "third parties" to the exchange will not be asked to take title to property nor to sign a contract for property that they are not buying or selling. From the third party's perspective, the closings aren't much different from those that don't involve an exchange. But the cash flow at an exchange closing is often different from that at the typical closing, and thus clear direction should be provided to the other party's attorney.

Is the paperwork for a 1031 exchange complicated? Yes and no. The tax regulations are complex and provide numerous legal "hoops" that you must jump through when setting up your exchange. Most of the work, however, can be handled by an attorney who knows the rules for like kind exchanges. This attorney also should oversee the closings to make sure the money is handled correctly so that the exchange is not inadvertently disqualified.

Can I hire a professional intermediary to set up my exchange? There are corporations that act as professional intermediaries and provide legal documentation as part of their services, but they specifically disclaim the giving of tax advice and typically do not oversee the exchange to ensure that it qualifies for tax deferral. For assurance that the exchange will meet all the tax requirements, you should consult an attorney or other tax professional who specializes in tax-deferred exchanges.

What are the most important ingredients for success in completing a 1031 exchange? You must have competent professional help, and you must have the ability to move quickly in making a deal on a suitable Replacement Property once you have a buyer for your Relinquished Property. Or, if you find your Replacement Property before you have a buyer for your Relinquished Property, you must have the means to own both properties simultaneously. But with good help, fortuitous timing, and a bit of luck, a successful exchange can be a piece of cake!