1031 Tax Exchange Frequently Asked Questions
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1031 Tax Exchange: Frequently Asked Questions
With a wealth of experience handling thousands of 1031 exchanges, we've identified several common questions about these transactions.
Understanding Equity and Gain
Is my tax based on equity or taxable gain?
Your tax is based on taxable gain, not equity. Calculate your gain by identifying the original purchase price, subtracting any reported depreciation, and adding the value of any property improvements. This gives you the cost or tax basis. The gain is the net sales price minus the cost basis.
Deferring All Gain
How can I structure an exchange to defer all taxable gain?
You can fully defer the gain by:
1. Purchasing a replacement property equal to or greater in value than the net selling price of the relinquished property.
2. Moving all equity from the sale to the new property.
Like-Kind Property Rules
Can I exchange different types of properties?
Yes, "like-kind" relates to the investment nature rather than property type. You can exchange investment real estate for investment real estate.
Simultaneous Exchange and Intermediaries
Can I complete a simultaneous exchange without an intermediary?
While possible, it’s not advisable. Using a qualified intermediary is crucial due to legal complexities involving constructive receipt. Without one, your exchange might not qualify for deferred gain treatment, risking IRS disqualification and tax penalties.
Converting Property
How long must I wait to convert investment property to a personal residence?
Although there's no official holding period, the IRS suggests a one-year period. It's recommended to hold the property for at least one year to demonstrate investment intent.
Involuntary Conversion
What if my property is involuntarily converted?
Under Section 1033, if a property is involuntarily converted (e.g., disaster, eminent domain), the reinvestment period extends to 24 months, with a possible 12-month extension.
Choosing Facilitators
Do facilitator capabilities vary? Should fees influence my choice?
Yes, facilitator expertise varies. Consider fees but prioritize their reputation, knowledge, and experience to ensure a successful transaction.
Personal Residence Exchanges
What are the rules for personal residence exchanges?
The 1997 Tax Reform Act allows up to $250,000 (single) or $500,000 (married) in capital gains exemption if the residence was your primary home for at least two of the last five years.
Exchanging and Improvements
Can I use proceeds to improve a lot I already own?
No, you cannot exchange into property you already own.
Related Party Transactions
Can I exchange a property with a relative?
Yes, but both parties must hold the properties for at least two years.
Partnership or Partial Interests
Can I exchange a partial interest in a property?
Yes, but only if your interest is direct, not as part of a partnership. Partnership interests don’t qualify for exchanges under Section 1031 unless under specific tax elections.
Reverse Exchanges
Are reverse exchanges legal?
Reverse exchanges can be done with experienced intermediaries and require careful planning. The IRS is expected to clarify these rules in the future.
Property Identification Rules
Why are the identification rules strict? Is there flexibility?
The 45-day identification rule is rigid, with no available extensions. When using the 200% rule to identify properties exceeding three in number, their total value must not exceed 200% of the relinquished property's value. The 95% exception allows identifying any number of properties, provided 95% of the identified properties are acquired.
Who should receive property identifications?
Identifications can be sent to intermediaries, attorneys, or escrow companies. It's safer to send them to an intermediary within the 45-day period.
By addressing these common questions, you can better navigate the complexities of 1031 exchanges and make informed decisions.
You can find the original non-AI version of this article here: 1031 Tax Exchange Frequently Asked Questions.
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