Selling Land

Five 1031 Exchange Rules

Five 1031 Exchange Rules

1031 exchange rules have been refined since being created by the Department of Treasury ninety years ago. The Internal Revenue Service (IRS) enforces a Treasury Regulation known as Section 1031 that provides all taxpayers with the ability to defer federal and state capital gain and recaptured depreciation taxes when property held for productive use in a business or investment is exchanged for like-kind property held for productive use in a business or investment. Supporting the 1031 code are 1031 exchange rules based on case law, regulations, revenue procedures, revenue rulings, private letter rulings, technical advice memorandum and other guidance from the IRS.

1031 Exchange Activity

The Joint Committee on Taxation estimates that in Tax Year 2004, the total dollar amounts deferred were $73.6 billion. In Tax Year 2011, the estimated total tax dollar deferral is $2.5 billion, with $.800 billion from individuals and $1.7 billion from corporations. In Tax Year 2012, the estimated tax deferral is projected to increase to $3.2 billion.

1031 Exchange Rules

The basic five 1031 exchange rules include:

  1. The federal and state capital gains taxes are deferred if the replacement property is equal to or greater than the property sold.The common misconception is that only the realized gain needs to be reinvested. Both the net equity and debt retired – if any – from the sale must be reinvested to defer 100 percent of the gain.
  2. A Qualified Intermediary (QI) must be engaged to accommodate the exchange. This cannot be your CPA , attorney, realtor or financial advisor or a related party such as your employee or lineal blood relative.One exception is in a pure exchange where the Taxpayer and Buyer want each other’s property. For the nominal QI fee, it still makes sense to engage a QI to make sure the 1031 exchange rules are followed.A second exception is if the attorney has provided services related to title closing, they can also accommodate the 1031 exchange.
  3. The taxpayer cannot touch or have access to the exchange proceeds or those funds are subject to taxation. Once the exchange proceeds are touched, the exchange is over.
  4. The taxpayer who sells is the taxpayer who buys. If the wife owns an investment property, then the wife is the titleholder to the replacement property. The husband can be quit claimed or added to the replacement property title after the closing.
  5. Following the first leg closing, the forty-five calendar day identification period begins, followed by an additional 135 calendar days to acquire the replacement property, for a total of 180 calendar days.

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About the author

Andy Gustafson, CES

Andy Gustafson, Certified Exchange Specialist®, is a managing member of Atlas 1031 Exchange, LLC, a nationwide accommodator of Internal Revenue Code Section 1031. He founded the company in 2007, and has since expanded his professional services into Texas and the Midwest. He has spoken to hundreds of investors at Wealth Camps and Real Estate Investment Clubs nationwide and is a sought after speaker on the topic. As an approved continuing educational provider, he has helped hundreds of Realtors, Attorneys, and CPAs understand the application of the 1031 code. To date he has accommodated over 500 exchanges representing $433,000,000 in exchanged value and deferring over $22,000,000 in taxes.

3 Comments

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  • One clarification on rule #5; it is the earlier of 180 days or the date the taxpayer files their federal income tax return. Something to keep in mind for those who are closing on the sale of their first leg between now and April 15th. Generally your good with 180 days, but these have to be done 100% compliant with IRC Secion 1031 to qualify.

  • You are correct, Alex. If a taxpayer initiates an exchange after October 16th or 17th (depending upon whether a leap year is involved) the taxpayer will need to file a federal tax extension to receive the 180 calendar days.

    An example, if an exchange starts on November 5, 2011, the 180th day is May 3, 2012. If an extension is not requested, the exchange ends on April 15th.

  • Andy, In the “5 rules” article, 2004 had 73 billion in exchange deferred monies. 2011 had only 2.5 billion. Why the huge difference?

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