What is a 1031 Exchange? How does it apply to an owner of a Park City or Deer Valley property? Terms such as second homes, "like-kind", deferred exchange, reverse exchange, qualified intermediary, and securities properties are all so confusing. Can stocks and bonds, cattle, fine art work, vacant lots, businesses be part of a 1031 exchange? Maybe, maybe not.
I have helped many owners buy and sell their properties, navigating the very often times overwhelming process of 1031 exchange. Let my experience, and team of professionals help you on a successful and valid exchange.
The United States Internal Revenue Service (IRS) Code, under Section 1031 (hence it's name), taxpayers may defer recognition of capital gains and related Federal income tax liability on the exchange of certain types of properties. Here are some commonly asked questions pertaining to the local real estate market.
Does second home qualify for 1031 Exchange?
Until 2008 many people were exchanging in and out of their second homes as there was little to no guidance surrounding what did and did not constitute property held for investment. Finally, in Revenue Procedure 2008-16 the IRS has clearly defined what is acceptable. This revenue procedure creates a safe harbor for taxpayers wishing to use Section 1031 with properties that follow a simple set of rules:
For a minimum of two years prior to, and after the exchange:
The property must be rented for a minimum of 2 weeks to a non-relative.
You can rent to a relative if it is their primary residence at fair market value rent.
The property must only be used personally for 2 weeks or 10% of the time rented.
You can maintain the property for an unlimited amount of time, but documentation must be kept for these activities.
The property should be placed on Schedule E of your tax return and reported as income property.
What is the time limits or timeline for 1031 Exchange?
The 1031 exchange begins on the earliest of the following:
the date the deed records, or
the date possession is transferred to the buyer,
and ends on the earlier of the following:
180 days after it begins, or
the date the Exchanger's tax return is due, including extensions, for the taxable year in which the relinquished property is transferred.
The identification period is the first 45 days of the exchange period. The exchange period is a maximum of 180 days.
What criteria qualifies a property for a valid 1031 Exchange?
In order to qualify for this exchange, certain rules must be followed:
Both the relinquished property and the replacement property must be held either for investment or for productive use in a trade or business. A personal residence cannot be exchanged.
The asset must be of like-kind. Real property must be exchanged for real property, although a broad definition of real estate applies and includes land, commercial property and residential property. Personal property must be exchanged for personal property. (There are some complicated rules surrounding this — for example, livestock of opposite sex are not considered like-kind property for the purpose of a 1031 exchange, and property outside the United States is not considered of "like-kind" with property in the United States.)
The proceeds of the sale must be re-invested in a like kind asset within 180 days of the sale. Restrictions are imposed on the number of properties which can be identified as potential Replacement Properties. More than one potential replacement property can be identified as long as you satisfy one of these rules:
The Three-Property Rule - Up to three properties regardless of their market values. All identified properties are not required to be purchased to satisfy the exchange; only the amount needed to satisfy the value requirement.
The 200% Rule - Any number of properties as long as the aggregate fair market value of all replacement properties does not exceed 200% of the aggregate Fair Market Value (FMV) of all of the relinquished properties as of the initial transfer date. All identified properties are not required to be purchased to satisfy the exchange; only the amount needed to satisfy the value requirement.
The 95% Rule - Any number of replacement properties if the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate FMV of all the potential replacement properties identified. In other words, 95% (or all) of the properties identified must be purchased or the entire exchange is invalid. An exception to the 95% rule is that if you close on a property within the 45 day period it still qualifies for the exchange.
Additional questions include:
What is boot?
What qualifies for "like-kind"? Does that include fine art, coin collection, cattle, stocks, bonds, vacant land?
What's the difference between deferred exchange and reverse exchange?
What questions do you ask when selecting a qualified intermediary?
Congratulations on having profits. Plan early before you list and sell your home so you can use the money wisely. Whether it's to invest more properties, leave a inheritance for your family, fund your children's education, or prepare for retirement, let me help you.I have successfully helped buyers and sellers in performing valid 1031 Exchange. For a complete list of resources and guidelines for 1031 exchanges, please email me at firstname.lastname@example.org