1031 Exchange Frequently Asked Questions
We have been helping real estate investors with 1031 Exchanges for almost 30 years. At Realty Exchange Corporation, we have completed thousands of successful exchange transactions.
Whether this is your first exchange or you just need a refresher on how 1031 Exchanges work, here are some answers to the questions that come up most often.
If you want to know more about how we can help you, contact us today!
1031 Exchange basics
What is a tax-deferred exchange?
1031 Exchanges or a tax-deferred Exchange that allows a taxpayer to exchange an investment or business property and defer the payment of the capital gains tax.
What kinds of properties quality for a 1031 Exchange?
The properties must be like-kind. This means that the property being relinquished must currently be considered investment real estate, this definition can apply to land, commercial property, or residential rental property.
What are examples of properties that quality for a 1031 Exchange?
There are several different properties that qualify for a 1031 Exchange, these include but are not limited to:
- Commercial Property
- Rental Property
- Apartment Buildings
Are there properties that DO NOT qualify for 1031 Exchanges?
- Principal Residences do not qualify,
- A Second Home might not qualify as an investment property. Read if yours does HERE,
- Dealer Property, which is property held as inventory, this definition most often applies to new construction or properties being flipped,
- Partnership interests may not be exchanged,
- Reverse Starker exchanges are not covered under Section 1031,
- The purchase of the replacement property from a related party should be avoided,
- A vacation property might not qualify, read more to see if your vacation property qualifies.
How is the replacement property identified?
Normally, up to three potential replacement properties are identified by address or legal description. The identification must be in writing, signed by the exchanger and delivered to the qualified intermediary.
What authorizes a deferred exchange?
While exchanges have been used for many years, in June 1991, IRS regulation 1.1031(k) provided specific and clear guidance to implement the famous “Starker” case decisions.
Most of IRC Section 1031 as it reads today was passed in the Deficit Reduction Act of 1984. The section was modified in 2017 to only apply to real property.
What is the timeline for a 1031 Exchange?
The replacement property that is desired to purchase must be identified within 45 days, be anywhere in the United States, and be settled in 180 days.
Can you do a 1031 exchange with a family member?
- DO NOT BUY DIRECTLY FROM RELATED PARTIES! This includes but is not limited to parents, siblings, children, grandchildren, or entities collectively controlled by related parties. There are very few exceptions to this rule.
- You are permitted to sell your relinquished property to related parties.
Finances related to 1031 Exchanges
How are capital gains figured?
The potential capital gains that can be deferred is simply the profit plus all the depreciation taken on the property being relinquished. Realty Exchange Corporation has created this simple Capital Gain Calculator to estimate the tax impact if a property is sold and not exchanged, and to calculate the reinvestment requirements for a tax-free exchange.
How much tax will I have to pay?
After you decide if your property will qualify for an exchange, you should decide if you should simply sell the property and pay the tax, or do an exchange and defer all the capital gains tax. To estimate the federal income tax you will have to pay if you sell the property and do not do an exchange, use our simple Gains Calculator to get a tax estimate.
What are the reinvestment requirements in an exchange?
One of the primary objectives of a tax-deferred exchange is to defer paying any tax on the gain realized when you sell the relinquished property.
- Rule 1: The replacement property must have an equal or greater acquisition
cost than the adjusted sale price for the relinquished property.
- Rule 2: The exchanger may not receive cash – all the proceeds in the qualified escrow account must be reinvested.
- Rule 3: The new or assumed mortgage total should be equal to or greater than the debt paid off on the relinquished property, or the Exchanger must add new cash to offset the difference.
- Rule 4: Taxpayer may not receive non-like property — including owner held notes, cash or personal property.
Read more about reinvestment requirements HERE.
How are the exchange escrow funds controlled and secured?
The qualified intermediary normally controls the funds so that the exchanger has no right “to receive, pledge, borrow, or otherwise obtain benefits of the cash…held in the escrow account.”
REC has created the AlwaysSafe Escrow Security System to ensure clients will remain confident in the secuirty of their funds.
Realty Exchange Corporation only holds funds in federally insured accounts. Virginia law, Section § 55.1-800, Exchange Facilitators Act – under which Realty Exchange Corporation is covered, and rigorously complies, establishes strict rules to safeguard exchanger escrow funds.
How did the Tax Reform Bill of 2018 effect 1031 exchanges?
Thanks to Federation of Exchange Accommodators (FEA) and member’s hard work to preserve 1031 exchanges, real property (real estate) exchanges were retained. Personal property (such as equipment, trucks, art) and intangibles ( franchise right, art, collectibles etc) were eliminated.
Personal property will now use 100% bonus depreciation from 1/1/2018 for 5 years.
If you have any questions regarding the IRS and your 1031 Exchange, give us a call! Don’t end up like this California Realtor.
What is a Qualified Intermediary?
The qualified intermediary is the person or entity facilitating the exchange, it is a role defined by the IRS to allow taxpayers to defer taxes. taxpayers cannot use just anybody to be their qualified intermediary. Primarily, that person cannot be directly related to the taxpayer, and/or cannot have agency with them.
So, you cannot have your accountant or your brother as your QI.
What does a Qualified Intermediary do?
The 1031 tax regulation states that there must be a qualified intermediary when accomplishing a deferred exchange of investment or business real estate.
Qualified Intermediary roles include, but not be limited to:
- Providing the Required Exchange Agreement
- Accepting Assignment of All Exchange Contracts
- Providing Notification of the Assignment to All Parties
- Furnishing Instructions to the Settlement Agent
- Establishing a Qualified Escrow Account
- Receiving the 45-day Identification Notice
- Delivering Escrow Funds for Settlement
- Arranging for Direct Deeding of Properties
- Giving a Final Accounting of Escrow Funds and Interest Earned
Can my relative be my Qualified Intermediary?
The qualified intermediary should be an experienced real estate professional who understands all aspects of the exchange and contract process.
IRS regulations specifically exclude the exchanger’s agent, broker, attorney, accountant, most family members and others with a business relationship with the exchanger from serving as the Qualified Intermediary (QI).
In short NO, your relative can not be your QI.
How can I begin a 1031 Exchange?
Agents or investors should contact Realty Exchange Corporation to discuss the proposed exchange and obtain the necessary contract addendum for the property to be relinquished.
There must be an exchange agreement signed by both the exchanger and Qualified Intermediary (QI) before the first relinquished property settlement.
1031 Exchanges don't have to be scary.
Since 1990 we have been helping real estate investors with 1031 Exchanges.
We’d love to teach you how 1031 Exchanges work, what to avoid, and how we can help!