Behind every 1031 exchange is a series of like kind exchange rules that if not applied invites the Internal Revenue Service to invalidate the exchange. As each 1031 exchange has an intent and facts that support the intent to qualify the transaction for a tax deferral, there are rules that must be followed. What follows is not a discussion of what real or personal property qualifies for a 1031 exchange but five common requirements.
The taxpayer who sells is the taxpayer who buys. The one exception is the single member of a limited liability company can acquire the replacement property in their individual name or vice versa. Husband and wife need to purchase as husband and wife. If the wife owns the property, then the wife needs to purchase the replacement property. The husband can be quit claimed on to the property deed once titled to the wife.
45 and 180 Calendar Day Timeline
Each exchange has two timelines. The first is within the initial 45 calendar days, the replacement property in a forward exchange must be formally identified. The second timeline is the exchange ends on the 180th day at 11:59 PM unless a Presidentially declared disaster extends the timelines.
The net equity and debt retired (if applicable) of the property sold must be equal to or greater in the replacement property to defer 100% of the taxable gain. For example, a property sold for $200,000 must be replaced with a property or properties of $200,000 to defer the gain.
A related party is either parents or children, brothers and sisters or an entity that owns more than 50% interest of a company owned by the taxpayer or beneficaries of a trust.
- Property sold to a related party must be held for two years, otherwise if sold earlier, the tax deferred is triggered.
- Property purchased from a related party requires the related party to also exchange their property and not cashing out.
The g(6) limitations of the 1031 code does not allow the taxpayer access to or benefit from the proceeds from the relinquished property sale. If the taxpayer were to receive a check from the sale and then decide to initiate a 1031 exchange, it is too late, unless the transaction can be unwound.
In Morton v. United States, the 1031 proceeds were mistakenly wired to the taxpayer. The funds were wired to the escrow account the next day. The Court did not invalidate the exchange stating the taxpayer should not be penalized for another's mistake given all steps were taken to initiate a like kind exchange.
There are many other rules that dependent upon the type of real or personal property requires the guidance and use of a qualified intermediary to accommodate the 1031 exchange.
If you would like to learn more about how a 1031 exchange works whether a forward, reverse or improvement exchange, call us at 850.496.0090. Or answer four short questions and we will call you.
What 1031 exchange rule do you not fully understand?