What is a Tax Deferred Exchange?
Who can do an Exchange?
What are the Disadvantages of an Exchange?
How is an Exchange Structured?
In a reverse exchange, the replacement property is acquired prior to the sale of the relinquished property. It must be structured correctly to qualify. You cannot own both the relinquished property and replacement property at the same time. This means that an “exchange accommodation titleholder” (EAT) either: (1) acquires title to the replacement property from the seller while you line up a sale of the relinquished property; or (2) acquires title to the relinquished property from you at the time the you acquire title to the replacement property. In either case, the maximum time period of a reverse exchange is 180 days, and you must have some means of financing the acquisition of the replacement property prior to availability of the relinquished property proceeds.
New improvements can be made to replacement property during the 180 day period in either a forward or reverse exchange, and these improvements will count towards the exchange value of the replacement property. This type of exchange must be structured correctly for the improvements to qualify as replacement property. This means the improvements must be made before you take title, by either the seller or in a forward or reverse “EAT” style arrangement.
The other requirements of the IRS regulations must also be met in addition to the time limitations.
How are the Exchange Funds Invested?
What are the Requirements of an Exchange?
1. Real Property Only. As of 1/1/18, only real property can qualify for tax-deferred treatment.
2. The Purpose Requirement. The taxpayer’s relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired primarily for sale will not qualify. Property held or acquired as a principal residence or primarily as a vacation or second home will also not qualify.
3. The Like-Kind Requirement. Replacement property acquired in an exchange must be “like-kind” to the real property being relinquished. All real property is generally like-kind to other real property so this requirement is typically easy to meet, but there are some exceptions.
4. The Exchange Requirement. IRC §1031 specifically requires that an exchange take place. That means that property must be exchanged for other property, rather than sold for cash. The exchange distinguishes an IRC §1031 tax deferred transaction from a taxable sale and purchase. Today, a deferred exchange is accomplished through a qualified intermediary to insure that the exchange meets the requirements of IRC §1031.
How do the Identification Rules Operate?
The taxpayer may identify one or more properties in the written identification. The maximum number of replacement properties that may be identified is:
1). Up to three properties, without regard to their fair market value (The Three-Property Rule);
2). More than three properties, but the total fair market value of all these properties at the end of the 45-day identification period cannot not exceed 200% of the total fair market value of all properties relinquished in the exchange (The 200% Rule).
For example, if the relinquished property value is $500,000, the written identification can include up to three properties of any value. If the identification contains more than three properties, then the total estimated value of the identified properties cannot exceed $1,000,000.
Any property actually received during the 45-day identification period is treated as properly identified, but does count as a property for the purposes of the Three Property Rule or the 200% Rule if the taxpayer identifies additional replacement property in a written notice. If the taxpayer exceeds both the Three-Property Rule and the 200% Rule, then the properties acquired after the 45th day do not count as replacement property in the exchange (unless the taxpayer acquires 95% of all the identified properties).
How is Taxable Gain Computed in an Exchange?
PLEASE NOTE THAT there are many exceptions to this rule and your taxable gain can be impacted by closing costs, including rent prorations and security deposits. Your taxable gain also can be impacted by several tax provisions, including depreciation and other recapture items, net operating losses, and special corporate and partnership tax provisions. We do not review your tax returns for items that may affect your taxable gain, and we do not undertake to calculate taxable gain in your exchange. YOU SHOULD CONSULT YOUR TAX ADVISOR PRIOR TO COMMENCING THE EXCHANGE REGARDING THE COMPUTATION OF POTENTIAL GAIN FROM THE EXCHANGE AND ANY SPECIAL TAX ITEMS THAT MAY IMPACT YOUR TAX CONSEQUENCES.