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STAN BOTELLO
Shorewood Realtors
3300 Highland Avenue
Manhattan Beach, CA 90266
310-795-0898
310-546-7561 Ext 463
Stan@SellingBeachProperty.com
Shorewood Realtors
3300 Highland Avenue
Manhattan Beach, CA 90266
310-795-0898
310-546-7561 Ext 463
Stan@SellingBeachProperty.com
Q & A Standard Exchange
Q: What is a 1031 Exchange?
A 1031 Exchange is a means of deferring capital gains taxes when selling investment property and purchasing like-kind investment property.
Q: What is "like-kind"?
With real property, like-kind means investment property for investment property. You can exchange an apartment complex for vacant land. The replacement property does not have to be income producing, but it must be held for investment purposes. Personal property exchanges must be "similar-in-use." A plane must be exchanged for a plane, veterinary equipment for veterinary equipment.
Q: How do I Identify a replacement property?
You will need to submit, in writing, your selections of replacement properties. You can identify up to three properties (without regard to value) or as many properties you would like (as long as the aggregate value of all properties identified does not exceed 200% of your relinquished property). The 95% Exception: Automatically used if neither of the above rules applies. Simply stated, the exchanger must acquire 95% of what was identified! This certainly keeps people from identifying entire blocks of potential properties!
Q: Can I get an extension?
Unfortunately the IRS will not issue an extension to the 45-day rule or the 180-day rule. However, if you are within your exchange period and your tax returns are due, you can file for an extension for your tax returns to receive the full 180 days allowed to complete your exchange.
Q: Can I use the proceeds for anything other than my property?
Any funds used for anything other than to purchase a new investment replacement property will be taxable and if taken from the exchange, or escrow, during your exchange period could jeopardize the integrity of your entire exchange.
Q: Can I purchase my replacement property before I sell my relinquished property?
This is called a reverse exchange. It is best to contact your qualified intermediary for more information due to complexity of the transaction.
Q: How do I calculate my gain?
Start with the price you paid for your property, subtract any depreciation, add any capital improvements. This figure is your adjusted basis. Subtract the adjusted basis and the new costs of sale from the new sales price and the remaining figure is your gain.
Q: What if I live in part of the property?
You can exchange a portion of your property if it has been held for investment purposes. Frequently a farm or ranch falls into this category. A multi-family property might also be part residential and part investment property.
Q: What happens if I buy down in value?
If you go down in value, you can still do an exchange to defer a portion of your transaction; however, you will pay taxes on any funds you receive upon completion of the exchange. Closing costs may also offset the price differential. You may wish to acquire more than one property!
Q: Can I exchange my vacation home?
Vacation homes fall under very strict guidelines to determine if they are actually investment property. If you've rented the property out while you owned it, it may qualify for tax deferral. In addition, if you have not personally used the property, you might be able to convince the IRS it was purely held for investment.
Q: I'm dissolving a partnership, how does that affect the exchange?
The same entity that relinquishes the property must acquire property to qualify for an exchange. If some of the partners simply want cash and do not intend to exchange, they can be cashed out when the sale closes and the partnership can remain intact and acquire property. However, if various partners want to go their separate ways but still want to exchange, then the only real option is for the partnership to deed the appropriate percentages to the various partners, before the sale closes. There is a risk in this, however, in that Section 1031 is for property HELD for productive use in business, trade or for investment purposes. If the partnership deeds to the individual partners, has the property been "held" by the individuals? The IRS has not defined what constitutes "held"!
Q: Can I exchange timber or water rights?
If timber rights have been held for a year or more, they can be exchanged for other timber rights. If the trees have not been removed from the property, they may be considered real property and exchangeable for other investment property. Each state handles timber rights differently. However, as a general guideline, if you acquired the timber rights via a deed as opposed to an assignment or bill of sale, they are probably considered real property. Similarly, state law determines whether or not water rights are real property. If the property was also used for investment purposes, the water rights could be exchangeable. Be sure to consult an attorney who specializes in timber or water rights, in your state, before entering into an exchange of this kind.
Q: Is a Qualified Intermediary needed if all properties are closing concurrently?
The IRS recommends in its regulations that a qualified intermediary be utilized in a 1031 exchange."
Q: What happens if I forgot to put a cooperation clause into my sales contract?
The cooperation clause is designed to clearly show the exchanger's intent to exchange. It is possible to accomplish the exchange by adding this statement after the initial acceptance of the offer, before the sale closes. Another way to accomplish this is to simply have the buyer sign the Assignment to the Purchase Contract prepared by the Qualified Intermediary (which is the extent of the cooperation required.) Certainly, for negotiation purposes, it's best to get an agreement to cooperate early in the transaction.
Q: Can I borrow against the funds held by the Qualified Intermediary?
Borrowing or pledging the funds would represent the Exchanger's control of the money, which would make it taxable and would disqualify the exchange.
Q: Can I take money out of the exchange?
The exchanger may receive funds at the close of the sale escrow (prior to the funds going to the Qualified Intermediary) by instructing escrow accordingly. No funds can be disbursed to the exchanger while held by the Qualified Intermediary.
Q: When can I obtain my money if I choose not to exchange?
In order to qualify for an exchange, the exchanger's access to the funds MUST be restricted by the Qualified Intermediary. IRS Code # 1031 clearly states the exchanger may receive the exchange funds if (1) he fails to identify within 45 days, he may receive the funds on the 46th day, or (2) if he fails to acquire the property, he may receive his funds on the 181st day. There may be some leeway if the exchanger is unable to acquire property identified due to a material fact beyond the exchanger's control. However, this would need to be determined on a case-by-case basis. Of course, if the exchanger acquires one property and has money remaining, those funds will be returned after notification to the Qualified Intermediary that there are no other properties to be acquired and the exchange is complete.
Q: Can I receive the interest on the funds while held?
Any interest earned by the exchanger can only be disbursed upon completion of the exchange. Otherwise the exchanger would be benefiting from the funds, which would constitute a "constructive receipt" of the funds and be taxable. The Qualified Intermediary will issue a 1099 statement for the tax year during which the interest was actually paid to the exchanger.
Q: Can the Qualified Intermediary advance funds from the exchange for the fees and costs needed to acquire the replacement property?
Funds can be disbursed to escrow for earnest money or common expenses such as appraisals and credit reports when the Qualified Intermediary has been assigned into the transaction in place of the exchanger. Funds must be requested by escrow (not the exchanger) to avoid the issue of the exchanger's control of the funds. If the exchanger advances any of these funds they can be reimbursed at the close of the escrow without triggering any taxes.
Q: I've been asked to carry a loan for my buyer, how does that affect the exchange?
A seller carry-back can be treated as an installment sale or may be deferrable upon certain conditions (call us for an in-depth review). The important thing to remember is that the method of handling a carry-back will have important tax ramifications to the exchanger and the options must be discussed and an action determined BEFORE THE SALE CLOSES.
Q: Can I improve property I already own?
You cannot trade real property for improvements, as they are not like-kind. Also, if you own both properties at the same time there can be no trade. Though there have been some recent encouraging court cases, if at all possible, do not acquire the replacement property until the improvements have been made. There are ways to make the improvements tax deductible via a "build-to-suit" or "workout" exchange--call us for details and a review of your particular situation.
Q: How many properties can I buy or sell in one exchange?
Buy as many as you can afford and can close within the same time period. Sell as many as you can provided they can all close within the time period set by the closing of the first sale.
Q: What is a 1031 Exchange?
A 1031 Exchange is a means of deferring capital gains taxes when selling investment property and purchasing like-kind investment property.
Q: What is "like-kind"?
With real property, like-kind means investment property for investment property. You can exchange an apartment complex for vacant land. The replacement property does not have to be income producing, but it must be held for investment purposes. Personal property exchanges must be "similar-in-use." A plane must be exchanged for a plane, veterinary equipment for veterinary equipment.
Q: How do I Identify a replacement property?
You will need to submit, in writing, your selections of replacement properties. You can identify up to three properties (without regard to value) or as many properties you would like (as long as the aggregate value of all properties identified does not exceed 200% of your relinquished property). The 95% Exception: Automatically used if neither of the above rules applies. Simply stated, the exchanger must acquire 95% of what was identified! This certainly keeps people from identifying entire blocks of potential properties!
Q: Can I get an extension?
Unfortunately the IRS will not issue an extension to the 45-day rule or the 180-day rule. However, if you are within your exchange period and your tax returns are due, you can file for an extension for your tax returns to receive the full 180 days allowed to complete your exchange.
Q: Can I use the proceeds for anything other than my property?
Any funds used for anything other than to purchase a new investment replacement property will be taxable and if taken from the exchange, or escrow, during your exchange period could jeopardize the integrity of your entire exchange.
Q: Can I purchase my replacement property before I sell my relinquished property?
This is called a reverse exchange. It is best to contact your qualified intermediary for more information due to complexity of the transaction.
Q: How do I calculate my gain?
Start with the price you paid for your property, subtract any depreciation, add any capital improvements. This figure is your adjusted basis. Subtract the adjusted basis and the new costs of sale from the new sales price and the remaining figure is your gain.
Q: What if I live in part of the property?
You can exchange a portion of your property if it has been held for investment purposes. Frequently a farm or ranch falls into this category. A multi-family property might also be part residential and part investment property.
Q: What happens if I buy down in value?
If you go down in value, you can still do an exchange to defer a portion of your transaction; however, you will pay taxes on any funds you receive upon completion of the exchange. Closing costs may also offset the price differential. You may wish to acquire more than one property!
Q: Can I exchange my vacation home?
Vacation homes fall under very strict guidelines to determine if they are actually investment property. If you've rented the property out while you owned it, it may qualify for tax deferral. In addition, if you have not personally used the property, you might be able to convince the IRS it was purely held for investment.
Q: I'm dissolving a partnership, how does that affect the exchange?
The same entity that relinquishes the property must acquire property to qualify for an exchange. If some of the partners simply want cash and do not intend to exchange, they can be cashed out when the sale closes and the partnership can remain intact and acquire property. However, if various partners want to go their separate ways but still want to exchange, then the only real option is for the partnership to deed the appropriate percentages to the various partners, before the sale closes. There is a risk in this, however, in that Section 1031 is for property HELD for productive use in business, trade or for investment purposes. If the partnership deeds to the individual partners, has the property been "held" by the individuals? The IRS has not defined what constitutes "held"!
Q: Can I exchange timber or water rights?
If timber rights have been held for a year or more, they can be exchanged for other timber rights. If the trees have not been removed from the property, they may be considered real property and exchangeable for other investment property. Each state handles timber rights differently. However, as a general guideline, if you acquired the timber rights via a deed as opposed to an assignment or bill of sale, they are probably considered real property. Similarly, state law determines whether or not water rights are real property. If the property was also used for investment purposes, the water rights could be exchangeable. Be sure to consult an attorney who specializes in timber or water rights, in your state, before entering into an exchange of this kind.
Q: Is a Qualified Intermediary needed if all properties are closing concurrently?
The IRS recommends in its regulations that a qualified intermediary be utilized in a 1031 exchange."
Q: What happens if I forgot to put a cooperation clause into my sales contract?
The cooperation clause is designed to clearly show the exchanger's intent to exchange. It is possible to accomplish the exchange by adding this statement after the initial acceptance of the offer, before the sale closes. Another way to accomplish this is to simply have the buyer sign the Assignment to the Purchase Contract prepared by the Qualified Intermediary (which is the extent of the cooperation required.) Certainly, for negotiation purposes, it's best to get an agreement to cooperate early in the transaction.
Q: Can I borrow against the funds held by the Qualified Intermediary?
Borrowing or pledging the funds would represent the Exchanger's control of the money, which would make it taxable and would disqualify the exchange.
Q: Can I take money out of the exchange?
The exchanger may receive funds at the close of the sale escrow (prior to the funds going to the Qualified Intermediary) by instructing escrow accordingly. No funds can be disbursed to the exchanger while held by the Qualified Intermediary.
Q: When can I obtain my money if I choose not to exchange?
In order to qualify for an exchange, the exchanger's access to the funds MUST be restricted by the Qualified Intermediary. IRS Code # 1031 clearly states the exchanger may receive the exchange funds if (1) he fails to identify within 45 days, he may receive the funds on the 46th day, or (2) if he fails to acquire the property, he may receive his funds on the 181st day. There may be some leeway if the exchanger is unable to acquire property identified due to a material fact beyond the exchanger's control. However, this would need to be determined on a case-by-case basis. Of course, if the exchanger acquires one property and has money remaining, those funds will be returned after notification to the Qualified Intermediary that there are no other properties to be acquired and the exchange is complete.
Q: Can I receive the interest on the funds while held?
Any interest earned by the exchanger can only be disbursed upon completion of the exchange. Otherwise the exchanger would be benefiting from the funds, which would constitute a "constructive receipt" of the funds and be taxable. The Qualified Intermediary will issue a 1099 statement for the tax year during which the interest was actually paid to the exchanger.
Q: Can the Qualified Intermediary advance funds from the exchange for the fees and costs needed to acquire the replacement property?
Funds can be disbursed to escrow for earnest money or common expenses such as appraisals and credit reports when the Qualified Intermediary has been assigned into the transaction in place of the exchanger. Funds must be requested by escrow (not the exchanger) to avoid the issue of the exchanger's control of the funds. If the exchanger advances any of these funds they can be reimbursed at the close of the escrow without triggering any taxes.
Q: I've been asked to carry a loan for my buyer, how does that affect the exchange?
A seller carry-back can be treated as an installment sale or may be deferrable upon certain conditions (call us for an in-depth review). The important thing to remember is that the method of handling a carry-back will have important tax ramifications to the exchanger and the options must be discussed and an action determined BEFORE THE SALE CLOSES.
Q: Can I improve property I already own?
You cannot trade real property for improvements, as they are not like-kind. Also, if you own both properties at the same time there can be no trade. Though there have been some recent encouraging court cases, if at all possible, do not acquire the replacement property until the improvements have been made. There are ways to make the improvements tax deductible via a "build-to-suit" or "workout" exchange--call us for details and a review of your particular situation.
Q: How many properties can I buy or sell in one exchange?
Buy as many as you can afford and can close within the same time period. Sell as many as you can provided they can all close within the time period set by the closing of the first sale.
Please note: Many of the situations
above are
subject to varied interpretations and/or require more detailed
information than space allows. Check with your CPA or tax attorney
before proceeding with your exchange.
Information provided with the permission of Exchange Resources, Inc.
Providing Intermediary Services for Los Angeles, Orange County, San
Francisco, Dallas and the Inland Empire.