Realtors are usually one of the first to determine that a 1031 exchange should be considered when an individual, husband and wife or company is selling real estate. “Usually” is the operative word given the seller may not share their intent to replace with another property. Nonetheless, whenever the seller is selling a property that is not their primary residence, the question, “Does a 1031 exchange make sense?” should be asked. Be sure to have a couple of qualified intermediaries to refer who can readily answer questions. As a qualified intermediary (QI), I receive calls from sellers and Realtors who just closed or closed the selling transaction a couple of weeks ago to ask “Is it too late?” Yes, once the seller has access to the net proceeds, the exchange cannot take place unless the transaction is unwound and restarted.
A 1031 exchange allows the seller to defer federal and state capital gain and depreciation recapture taxes when selling and replacing with like-kind property. To avoid discussing taxes, the suggestion is for the seller to visit with their CPA to determine the tax consequences of the sale. If the result is not to enter into a 1031 exchange, at least the Realtor has provided the guidance for the seller to determine with the financial counsel whether a 1031 makes sense.
A 1031 exchange is either a forward or a reverse. In a forward, the relinquished or old property is closed on before the replacement property is acquired. In a reverse, the replacement property is acquired before the relinquished property is closed. Improvements to replacement property can be funded from the exchange funds.
Like-kind property means real, tangible or intangible personal property must be replaced with real, tangible or intangible personal property. Real property held in the US, such as a single family residential property held for rent and not primarily for personal use, can be exchanged for any real property in the US. Eligible replacement property includes land, commercial property and oil and gas royalties.
One of the many Internal Revenue Code 1031 requirements is that the rights, not the obligations of the purchase and sale agreement (PSA) are assigned to the QI. In the relinquished property PSA, the Seller can assign the rights without the written permission of the Buyer unless otherwise stated in the contract to the QI. When the exchangor is buying, the assignment language must be included in the PSA. Many state Realtor Association PSAs have 1031 language already embedded.
Multiple Commission Potential
Once the seller initiates a 1031 exchange and closes on the first leg (commission number one), the 180 calendar day clock begins. The seller must acquire a replacement property or multiple replacement properties or the exchange fails. Given the replacement property is within the market the Realtor serves, the Realtor is in position to sell the replacement property (commission number two) to the client. I have facilitated many 1031 exchanges where multiple properties were sold and multiple replacement properties were acquired with the same Realtor.
A 1031 exchange may appear confusing to the uninformed, but is really where a property is sold and replaced with a property of equal or greater value to the relinquished net sales price. Partial 1031 exchanges are also acceptable. There are many rules and exceptions to apply, but put that burden on the QI to qualify. Realtors are serving and separating themselves from their competition by understanding the value in suggesting to their clients “You should ask your CPA the tax consequences of the sale and whether a 1031 exchange makes sense.”
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