Following requirements for 1031 exchanges to the letter is absolutely critical to realizing the investment benefits and avoiding costly penalties.
The exchange process must be facilitated by a Qualified Intermediary (QI), the professional who actually executes the exchange. QIs hold the proceeds from the property you sell until they are reinvested in the exchange property. There must be a written "exchange agreement" between you and the QI to prevent you from having "constructive receipt" of the funds during the exchange period. The QI is required to complete a valid 1031 exchange that ensures all roles are followed and equity is preserved during the process. Using a QI as an intermediary as an independent party to facilitate a tax-deferred exchange is a safe harbor established by Treasury Regulations, and it is very important for you to select a QI before closing on your sale property. We can work with any authorized QI of your choice, or we can suggest one who is fully bonded and has a national reputation.
The properties involved must be “like-kind.” This requirement is liberally interpreted, and virtually all real estate properties, whether raw land or those with substantial improvements, qualify as like-kind. However, REITs, real estate funds or other securities do not qualify for 1031 exchange. Types of like-kind properties may include:
- Raw Land
- Multi-Family Rentals
- Single-Family Rentals
- Retail Shopping Centers
- Office Buildings
- Industrial Facilities
- Storage facilities
You must follow strict identification and timeline rules for a 1031 exchange to the letter:
- You must identify the exchange properties in writing within 45 days of the closure for the relinquished property in accordance with one of the following rules:
- Three-Property Rule: Identification of up to three properties regardless of the total value of property identified
- 200% Rule: Identification of any number of properties wherein the combined FMV (fair market value) does not exceed 200% of the relinquished properties' FMV
- 95% Rule: Identification of any number of properties regardless of the aggregate FMV, as long as at least 95% of the property is ultimately acquired.
- You must also close on the replacement property or properties within 180 days of the closure for the relinquished property.
Other requirements include:
- You must hold the properties for productive use in a business or for the purpose of investment.
- The replacement property must be of equal or greater value than the property you sold.
- The equity of the replacement property must be of equal or greater value than the equity of the property you sold.
- The debt held by the replacement property must be of equal or greater value than the debt held by the property you sold unless you offset lower debt on the replacement property by adding cash to the exchange.
- All net profit from the relinquished property must be used in the purchase of the replacement property.