1031 Exchange FAQs

A 1031 exchange, also known as a like-kind exchange, allows qualifying real property held for investment or business purposes to be exchanged for other qualifying real property while potentially deferring recognition of gain.

Section 1031 currently applies to real property, rather than personal or intangible property.

Section 1031 generally applies to real property held for productive use in a trade or business or for investment.

Property held primarily for sale does not qualify. Personal property and most intangible assets are also outside the current scope of Section 1031.

No. The term "like-kind" is broader for real estate than many investors assume. Qualifying real properties can generally be like-kind even when they differ in grade, quality, or property type.

For example, an investor may potentially exchange one type of investment real estate for another type of qualifying investment real estate.

A property used solely as a personal residence generally does not qualify because Section 1031 applies to property held for business or investment purposes.

Special considerations can apply to properties that have both personal and investment use. The IRS has established a safe harbor addressing certain dwelling units held for investment while also receiving limited personal use.

Investors with mixed-use, vacation, or previously rented properties should discuss their circumstances with a qualified tax professional.

Two deadlines are especially important in a typical deferred exchange. You generally have:

• 45 days after transferring the relinquished property to identify replacement property
• 180 days after transferring the relinquished property to receive the replacement property, subject to the applicable federal income tax return deadline

Both periods begin when the relinquished property is transferred.

The regulations provide several methods for identifying replacement property. The most commonly discussed include:

• The 3-Property Rule
• The 200% Rule
• The 95% Rule

Each has specific requirements, so investors identifying multiple properties should understand the applicable rules before the 45-day identification period expires.

The 45-day identification deadline is a significant requirement of a deferred exchange. If qualifying replacement property is not properly identified within the applicable identification period, property acquired later generally will not satisfy the deferred exchange identification requirement.

This is one reason replacement property planning should ideally begin before the relinquished property closes.

Ideally, before your existing property closes. Starting earlier gives you more time to:

• Clarify your investment objectives
• Establish replacement property criteria
• Engage a Qualified Intermediary
• Consult with your tax and legal professionals
• Evaluate potential replacement property strategies

Waiting until the 45-day identification period is already underway can significantly reduce the time available to evaluate your options.

A Qualified Intermediary, often called a QI, is commonly used to facilitate a deferred 1031 exchange.

The QI structure can provide a regulatory safe harbor designed to prevent the investor from having actual or constructive receipt of the sale proceeds while the exchange is underway.

Customized 1031 does not serve as the Qualified Intermediary. Doug can work alongside your QI while helping you evaluate the replacement property and investment side of the exchange.

Generally, taking actual or constructive receipt of the sale proceeds can prevent a transaction from qualifying as a deferred exchange.

This is one reason exchange arrangements are typically established before the relinquished property closes and why investors commonly use a Qualified Intermediary.

Potentially, yes. Qualifying real property within the United States can generally be like-kind even when the relinquished and replacement properties are located in different states.

However, U.S. real property is not considered like-kind to real property located outside the United States.

Potentially. A 1031 exchange can involve multiple replacement properties, provided the transaction and identification satisfy the applicable requirements.

Investors considering multiple properties should pay particular attention to the identification rules and overall exchange structure.

Certain Delaware Statutory Trust structures may allow an investor to acquire an interest that is treated as an interest in real property for purposes of Section 1031.

IRS Revenue Ruling 2004-86 addresses a specific DST structure and concludes that an interest in the trust described in the ruling may be acquired without recognition of gain or loss under Section 1031 when the applicable requirements are satisfied.

DSTs are securities and involve investment risks and suitability considerations. They are not appropriate for every investor.

Receiving cash or other non-like-kind property does not necessarily cause the entire exchange to fail.

However, gain may be recognized to the extent of money or other non-like-kind property received, subject to the applicable tax rules. Liabilities can also affect the calculation.

Your tax professional should evaluate the specific tax consequences of your exchange.

A 1031 exchange is generally a tax-deferral strategy, not an automatic elimination of tax.

When the requirements are satisfied, recognition of gain may be postponed and the basis of the relinquished property generally carries into the replacement property subject to applicable adjustments.

Future tax treatment will depend on what happens with the replacement property and the investor's individual circumstances.

Like-kind exchanges are generally reported using IRS Form 8824, Like-Kind Exchanges, which is filed with the federal income tax return for the year of the exchange.

Form 8824 is used to report information about the properties exchanged and to calculate deferred and recognized gain, as applicable.

Investors should work with their tax professional to properly report the transaction.

A 1031 exchange can involve several professionals with different responsibilities. Depending on the transaction, your team may include a:

• Qualified Intermediary
• CPA or tax professional
• Attorney
• Real estate broker
• Lender
• Investment professional

Customized 1031 focuses on helping investors understand and evaluate the replacement property and investment side of the decision while working alongside the other professionals involved.