I own my property as a partnership, will that affect my 1031 Exchange?

For tax and liability reasons investment real estate is commonly owned by an entity other than the investor (corporations, partnerships, trusts etc.).  When doing an exchange it is important to note that these various forms of ownership have different tax treatment that may affect the exchange.  1031 law states that the owners of the relinquished property and replacement property must be the same taxpayer.

If a partnership owns property and wants to use an exchange, it must acquire the replacement property under the same partnership name.  Frequently, individual members desire to cash out when the property sells and purchase replacement property under their own name, not as a partnership. This could result in significant tax risk because the ownership of the relinquished and replacement properties is not the same.

Another option can be to dissolve the partnership prior to initiating the exchange and distribute ownership to the members as tenants in common. The individual partners can then exchange their ownership portions separately without the partnership as owner of the replacement property.  It is important that the relinquished property be held by the individual owners for a decent interval of time in order to comply with the "held-for" investment requirement of 1031 Exchanges.

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Can I purchase a property from a family member or related party?

1031 tax law permits the sale of property to a related party if that property is sold at a fair market rate and will be held by the related party for at least two years.  Purchasing a property from a related party is rarely allowed unless the selling party is also doing an exchange and even then strict rules may apply to the transaction.  The IRS has issued some varying court rulings on related party cases and extra consideration and analysis is advisable when considering an exchange involving a related party. 

For purposes of the like-kind exchange rules, the definition of related parties is a combination of related parties as defined under IRC section 267(b) and section 707(b). Related parties include the following:

• Family members (siblings, spouses, ancestors, and lineal descendants)
• An individual and an entity (corporation or partnership) where the individual owns either directly or indirectly more than 50% in value of the entity
• Two entities in which the same individual owns directly or indirectly more than 50% of each
• An estate in which the taxpayer is either the executor or beneficiary of the estate
• A trust in which the taxpayer is the fiduciary and the related party is a beneficiary either of that same trust or a related trust or a fiduciary of a related trust

What if I want to sell more than one property? Can I still use a 1031 Exchange?

In situations where the taxpayer is selling multiple properties, it must be determined whether the taxpayer intends to engage in several exchanges, or combine the funds in order purchase a property of greater value.  If multiple properties will be combined to purchase one property it is important to note that the 45 and 180 day timelines will begin on the closing of the first relinquished property and will not reset when the other properties close.  The practical meaning of this is that the closing of the relinquished properties should take place in as short a timeframe as possible.  This technique can be a great way to consolidate real estate holdings and defer taxes at the same time.

Contact the 1031 Exchange Specialist or call us at 866-405-1031

How many replacement properties can I identify?

There are three options for identifying replacement property.  By far the most common option is the “three property rule” which allows the exchanger to identify up to 3 qualifying properties regardless of value.  Another option is the “200% rule” where any number of properties can be identified as long as the total aggregate value does not exceed 200% of the relinquished property sales price.  The third choice is the 95% rule allowing any number of properties of any value to be identified but 95% of the total value of identified properties must be purchased. 

A person using a 1031 Exchange must choose one of these three options and submit their identification in writing to the accommodator prior to the end of the 45^th day from the close of the relinquished property.  Prior to that 45^th day deadline the identification can be altered if needed and properties can be added to or removed from the identification form.  The essential fact to plan for is that the identification form cannot be altered in any way after day 45.  To reduce some pressure of this timeline it is advisable to begin locating possible replacement property even before the closing of the relinquished property. 

Contact the 1031 Exchange Specialist or call us at 866-405-1031

How much money do I need to reinvest into the replacement property?

In order to defer all of the capital gains tax in a 1031 Exchange, the value of the replacement property(s) must be of equal or greater value than the property that was sold.  If the value of the purchase property is less, tax will be applied to the difference.  In addition, all the cash proceeds (after any liens have been paid) must be rolled into the replacement property with tax being applied to any amount not reinvested. 

An example:  Property A sold for $500,000 and had a mortgage of $300,000 resulting in cash proceeds of $200,000. 

• The client doing a 1031 Exchange puts $100,000 down payment each on properties B and C which are each being purchased for $350,000 apiece.  Total cash used is $200k and total purchase price is $700k.
• In this case the exchanger 1. Reinvested all of the cash ($200k) from the sale, and 2. Purchased property of greater value than the sales price ($500k) and therefore met all the requirements to defer the taxes. 

In the same example: If the down payment was reduced to $50,000 each on properties B and C and their price was reduced to $200,000 each, the taxpayer would need to pay some taxes. Total cash used is $100k and total purchase price is #400k.

• Only half of the $200k in cash was reinvested, so the difference of $100k could be taxable. 
• Additionally the total amount of property purchased was $400k, or $100k short of the sales price of $500k, so tax could be assessed on the $100k difference. 

Contact the 1031 Exchange Specialist or call us at 866-405-1031

Section 1031 of the IRS code provides an investor with a huge opportunity for creating wealth and preserving gains through tax deferral. However, the tax code does have many gray areas that lead to some important questions with no clear answer. One common question is what length of ownership is appropriate for an exchange?

The short black and white answer is: the longer the better. The gray are lies in the fact that the IRS has no specific time limits written into the 1031 tax code but there are anecdotal guidelines that seem to be generally accepted. Many tax professionals advise that property held longer than 2 years is typically approved while a hold time of less than 12 months (“a year and a day”) can raise red flags. The most important factor to consider is what the intention was at the time of purchase. The purchase cannot be a quick “flip” for profit but rather a long-term hold. It is advisable to speak with a tax professional to discuss individual circumstances.

For all your answers on 1031 exchanges call the 1031 exchange specialists at 866-405-1031