1031 Exchange Rules FAQs

This page includes some of our most frenquently asked questions about 1031 Tax Exchange Rules. We hope you find it very helpful. If you have any 1031 Tax Exchange questions, go to our ask a question page.

  1. What property is like kind to my property?
  2. What must I do to have a fully deferred exchange?
  3. May I have a partially tax deferred exchange?
  4. What is boot?
  5. Down payment and loan reduction
  6. Fix up
  7. Mortgage
  8. How long do I have to identify, how do I identify, what constitutes sufficient identification, is there any leeway?
  9. How long do I have to purchase my replacement?
  10. May I do a multiple leg exchange?
  11. May I exchange less than 100% of my interest?
  12. How should I take title to replacement property?
  13. What is a related party and can I do an exchange with them?
  14. Do I receive a cost basis in my replacement property?
  15. Can an entity do an exchange? corporation, partnership, LLC, trust
  16. Can I receive title to replacement property before giving up title to relinquished property?
  17. Can I use exchange funds to pay down mortgage on property I already own?
  18. Can I use exchange funds to do fix up on replacement property?
  19. Can I use exchange funds to build improvements on replacement property?


 

     

  1. What property is like kind to my property?

    When it comes to real estate, all real property is like kind to all other real property. For example, farm land can be exchanged for an office building, a condominium can be exchanges for a trailer park. The definition of real estate will be defined by the state law of the jurisdiction in which the property is located. Our business focuses on exchanges of real estate. Certain other tangible personal property can be exchanged, like airplanes and equipment. Whether this property is like kind is determined by reference to certain industrial classifications. We can handle exchanges of real estate or personal property.

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  2. What must I do to have a fully deferred exchange?

    The general rule is that, in order to have a fully tax deferred exchange, the exchanger must trade equal or up in equity and equal or up in fair market value. The effect of this rule is that the exchanger must use the entire net proceeds from the relinquished property as down payment on the replacement property. Also, the exchanger must replace any mortgage paid off at the sale of the relinquished property with an equal or greater mortgage on the replacement property. Any cash received by the exchanger whether at the sale of the relinquished property or at the purchase of the replacement property will be deemed "cash boot" and tax will be recognized to the extent of gain. This rule applies regardless of the exchanger's cash position in the relinquished property. Regardless of the size of the exchangers down payment, principal pay down, or capital improvements on the relinquished property, the exchanger will be treated as having received "cash boot" if cash is received as part of the exchange. The fair market value of the relinquished property can be calculated from the selling price by subtracting from the selling price the transaction costs of the sale. These transaction costs are limited to those costs directly related to the sale of the relinquished property. The most common transaction costs are brokerage fees, title insurance fees, exchange service fees, and recording fees.

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  3. May I have a partially tax deferred exchange?

    If the rule described in answer two above is violated, a partially tax deferred exchange is the likely outcome. If the exchanger trades down in either fair market value or equity then some gain is likely to be recognized. If the exchange is otherwise valid, a partially deferred tax exchange is the result. (Also see answer to question 4, below.)

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  4. What is boot?


    "Boot" is anything of value received by the exchanger which is not "like-kind" to the relinquished property.

       

    • 4a.) Cash boot

      If the exchanger receives cash upon sale of the relinquished property this will be treated as "cash boot" and tax will be recognized to the extent of gain in the transaction. For example, if the QI receives $40,000 upon sale of the relinquished property and the exchanger elects to receive $10,000 in cash at closing, the exchanger will pay tax on $10,000 while the exchange is completed with the remainder of the funds held by the QI.

       

    • 4b.) Mortgage and other boot

      If the exchanger fails to purchase a replacement property of equal or greater value than the relinquished property there is a strong possibility that he will be deemed to have received "mortgage boot." For example, if the exchanger relinquishes a property valued at $100,000 and deposits $50,000 with their QI and a $50,000 mortgage is paid off, then replaces with a property valued at $90,000 with $50,000 cash down and a replacement mortgage of $40,000 the exchanger will pay tax on $10,000. This is an example of the receipt of "mortgage boot." A exchanger can also receive other property which will be deemed boot. For example, if the exchanger receives an automobile, art work, or any other thing of value as part of an exchange, that other non-like kind property will be deemed boot and taxed on the fair market value of the other property received.

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  5. Down payment and loan reduction

    Any cash received by the exchanger whether at the sale of the relinquished property or at the purchase of the replacement property will be deemed "cash boot" and tax will be recognized to the extent of gain. This rule applies regardless of the exchangers cash position in the relinquished property. Regardless of the size of the exchangers down payment, principal pay down, or capital improvements on the relinquished property, the exchanger will be treated as having received "cash boot" if cash is received as part of the exchange.

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  6. Fix up

    Often a relinquished property will require certain repair prior to sale or as a condition of sale. If the repairs are done prior to sale of the relinquished property and are paid directly to the person performing the repairs and deducted from the net proceeds then these amounts should be treated in the same fashion as mortgage. However, if the exchanger pays for the repairs prior to closing and then seeks reimbursement of these expenses he will be treated as having received "cash boot." This is another example of how our companys involvement in the structuring of the sale of the relinquished property can be beneficial to the exchanger if we are involved early enough in the transaction.

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  7. Mortgage


    Recent tax authority suggests that a refinancing of the relinquished property prior to sale with receipt of cash by the exchanger may not be deemed "cash boot" under certain limited circumstances. This allows the exchanger to balance equity in the relinguished and replacement property. In the event the exchanger needs cash for an independent business purpose, the exchanger can refinance the replacement property after acquisition and when the independent need for cash arises.

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  8. How long do I have to identify, how do I identify, what constitutes sufficient identification, is there any leeway?

    The replacement properties must be identified within 45 days after the transfer of the relinquished property. This requirement is strictly enforced, even if the 45th day falls on a holiday. Identification must be in writing, signed and dated by the exchanger and received by the QI no later than 45 days after the sale of the relinquished property. Replacement property must be identified unambiguously. Usually either a legal description or a mailing address is sufficient. Beware of an exchange where a exchanger identifies a property in whole and then closes on only a part of the whole. If challenged, this may not be sufficiently unambiguous identification for a successful exchange.

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  9. How long do I have to purchase my replacement?

    The replacement property must be purchased within 180 days after the transfer of the relinquished property.

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  10. May I do a multiple leg exchange?

    Yes. Several relinquished properties may be exchanged for a single replacement property. One relinquished property may be exchanged for several replacement properties. The important thing is that the exchange be part of a unified exchange agreement from the beginning. The 45 day identification rule and 180 day replacement rule will start running from the date of the sale of the first relinquished property. Sometimes because of this timing issue it is better to structure the exchange as a series of exchanges rather than a multiple leg exchange.

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  11. May I exchange less than 100% of my interest?

    Yes. A fractional part of the relinquished property may be exchanged and/or a fractional part of the replacement property may be acquired.

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  12. How should I take title to replacement property?

    Title to the replacement property must be taken by the same taxpayer in which the relinquished property was held. Caution dictates that this rule be followed even when husbands and wives are involved.

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  13. What is a related party and can I do an exchange with them?


    This is an evolving area in 1031 exchanges. Generally speaking, if an exchange where related persons swap properties then all exchanged properties must be held for a period of two years after the date of the last transfer or the exchange will not qualify for tax deferral. Related parties are defined as: lineal ancestors and descendants, brothers and sisters and other entities which the exchanger owns at least a 50% interest. In a deferred exchange, the exchanger cannot buy from a related party unless tax savings is not an issue. In a deferred exchange, the exchanger may sell to a related party.

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  14. Do I receive a cost basis in my replacement property?

    No. Tax basis from the relinquished property is carried forward into the replacement property. Tax basis in the replacement property is increased by any additional cash or increase in mortgage by the exchanger. Once a depreciation allowance is taken on the relinquished property it may not be used a second time on the replacement property. This rule is generally regarded as a negative consequence of a 1031 exchange. It is frequently misunderstood by both investors and brokers.

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  15. Can an entity do an exchange? corporation, partnership, LLC, trust

    Yes. Title to the replacement property must track with the relinquished property. A partnership interest in one partnership may not be exchanged for a partnership interest in another partnership. A share of stock in one company may not be exchanged for a share of stock in another company. However, legal entities may perform exchanges under 1031.

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  16. Can I receive title to replacement property before giving up title to relinquished property?

    Reverse 1031 exchanges are permitted. However, the exchanger may not hold title to both properties at the same time. Instead an Exchange Accommodation Titleholder must hold title to one of the properties. Contact us for more detail.

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  17. Can I use exchange funds to pay down mortgage on property I already own?

    No. This is not considered a like kind exchange by the IRS.

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  18. Can I use exchange funds to do fix up on replacement property?


    It is generally best to have the owner of the replacement property perform the fixup prior to acquisition of the replacement property. As a second alternative, it is better to use funds other than exchange funds to perform the fixup on the replacement property. Finally, exchange funds can be used to perform fixup on the replacement property if the fixup is accomplished prior to the exchanger actually acquiring title.

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  19. Can I use exchange funds to build improvements on replacement property?

    Generally speaking the best way to accomplish this goal is to have a "Special Purpose Entity" acquire title to the replacement property, have the Special Purpose Entity build the improvements, and have the exchanger acquire the replacement property from the Special Purpose Entity under the regulations for exchanges. Please contact us if you are asked to perform a construction exchange.

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