What is a 1031 Exchange and do I need one?
If you own property for investment or business purposes, you might consider Section 1031 of the Internal Revenue code. It allows investors to defer capital gains taxes on any exchange of properties for business or investment purposes. If the money is being used to purchase another property, the payment of tax can be deferred until the property is sold with no re-investment.
What are the requirements of a 1031 Exchange?
To qualify for a 1031 exchange, the seller cannot receive or control the net sale proceeds. Instead, the proceeds must be deposited with a Qualified Intermediary, and the cash invested in up to three replacement properties must be of equal or greater value than the cash received from the sale of the relinquished property.
Also, the taxpayer that will hold the title to the replacement properties must be the same person that held the title to the relinquished property. However, business considerations, liability issues, and lender requirements may make it difficult for the exchanger to keep the same vesting on the replacement property. Exchangers should anticipate these vesting issues as part of their advanced planning for the exchange.
Those looking to take advantage of a 1031 Tax Exchange should also be aware that there are some exceptions to this rule when dealing with entities that are disregarded for federal income tax purposes. For example, the exchanger’s estate may complete the exchange after the exchanger dies following the close of the sale of the relinquished property. Also, a husband and wife may exchange a relinquished property held individually as community property for a replacement property titled in a two-member LLC in which the husband and wife’s ownership is community property, but this is only a valid option in community property states and only if they treat the LLC as a disregarded entity.
As a rule, an exchanger should not consider any changes in the vesting of the relinquished property or replacement properties before or during the exchange. As the process can become very complicated, exchangers are encouraged to consult with their tax or legal advisors regarding how their vesting issues will affect the structure of their exchange.
Does my property qualify for a Section 1031 exchange?
A Qualified Intermediary can identify a property for a Section 1031 exchange. Up to three replacement properties must also be identified in a written document, known as an identification notice. This notice must include a specific description of the replacement property or properties, must be signed by the exchanger, and must include a legal description, street address or distinguishable name, and property to be produced if applicable.
A property qualifies for a Section 1031 exchange so long as the seller does not receive or control the net sale proceeds, and instead the proceeds are deposited with a Qualified Intermediary. The replacement property, however, must be “like-kind” to the relinquished property, identified within 45 days of the sale, and acquired within 180 days of the sale of the original property. The cash invested in the replacement property must be equal to or greater than the cash received from the sale of the relinquished property, and the debt assumed on the replacement property must be equal to or greater than the debt received from the relinquished property.
What is a Qualified Intermediary and how do I find one?
A Qualified Intermediary, also known as a “QI,” is usually a company that is in the full-time business of facilitating Section 1031 tax-deferred exchanges. They may also be accommodators, facilitators, or qualified escrow holders. One such company is McKesson Title, as we specialize in these exchanges.
The role of the QI is to enter into a written agreement with the taxpayer to transfer the relinquished property to the buyer and transfer the replacement property or properties to the taxpayer in accordance with the exchange agreement. The QI then holds the proceeds of the sale of the relinquished property in a trust or in escrow in order to ensure that the taxpayer never has actual or constructive receipt of the sale proceeds.
It’s important to know that some individuals are disqualified from serving as a QI in a Section 1031 exchange, such as those persons that have acted as the exchanger’s employee, accountant, attorney, investment banker, or broker. Because of this, it’s often best to go with an outside, third party company who can serve as your QI without violating this rule.
At McKesson Title, we’re experts in 1031 Tax Exchanges, and we offer intermediary services in every state. While the process can be complicated, we can make the exchange go smoothly for all parties involved. As a Qualified Intermediary, we can guide you through the entire process, beginning with an in-person, no-cost consultation. Contact us today!