AMT 1031 Frequently Asked Questions

A 1031 exchange is a swap of one real estate investment for another (of equal or greater value) which, if done correctly, will defer all (or substantially all) capital gains taxes that would otherwise have been due. It is imperative that the exchange meets all of the criteria laid out in Internal Revenue Code Section 1031 (hence the name “1031 Exchange”). If all of the criteria are not met, then the exchange fails and the capital gains taxes will be due from the transferor.  

To qualify, the property (or properties) being sold must be of like-kind to the property (or properties) being acquired.  The current rules interpret the term “like-kind” fairly liberally, which means pretty much any type of business or investment real estate can be exchanged for any other type of business or investment real estate. For example, one can sell a strip mall and acquire a high-rise apartment complex. Additionally, an investor may sell two short-term rental properties to acquire one manufacturing plant.

The vast majority of 1031 exchanges are known as delayed exchanges. That’s because the investor typically sells their current property first, and then searches for the desired replacement property. The acquisition is delayed until after the sale is complete. It is very important that the proceeds of the sale not go directly to the Seller. All proceeds must be directed to a Qualified Intermediary (QI). If the proceeds go to the Seller, even temporarily, then the exchange fails and the Seller will be responsible for the capital gains taxes. 

In addition to the requirement of a QI, there are two critical deadlines that must be met in order to qualify as a 1031 Exchange. The first is the 45 Day Rule, which gives the exchanger 45 days from the sale date to identify the potential replacement property. This must be done in writing and submitted to the QI within the allotted time. One can identify up to three potential properties so long as they end up acquiring at least one of the identified parcels. Technically, they can identify more than three parcels, but there are certain additional restrictions that will then apply and they are based on valuations.

The second rule requires that the replacement property be acquired within 180 days from the date the exchanged property was sold. It’s important to note that both of the aforementioned time periods commence upon the sale of the property being exchanged, not based on the date the replacement properties are identified. 

A Reverse Exchange is when the replacement property must be acquired prior to the sale of the property being relinquished. This scenario can happen for many different reasons, such as the potential loss of the purchase opportunity if the closing isn’t expedited. There are several types of reverse exchanges with the most common being a parking arrangement.  In this situation, the third-party exchange company takes title to the new property as the Exchange Accommodation Titleholder (EAT). This is accomplished with money loaned (or borrowed) by the exchanger and given to the EAT. Title to this new/replacement property is “parked” in the name of the EAT, until such time as the exchanger completes the sale of their current property. Note that the timeline of 180 days still applies to this type of transaction so the sale must be completed within 180 days of the acquisition of the replacement property by the EAT. When the sale is completed, a normal/forward exchange is completed whereby the exchanger sells their current property and acquires title to the replacement property from the EAT. Essentially, there are two separate, but required, components to complete a Reverse Exchange – the parking arrangement followed by a traditional forward exchange. 

Since 1031 prohibits the exchanger from using exchange funds to make improvements to property they already own, the improvements would need to be made to the replacement property prior to taking title. At the same time, the exchanger typically wants to use the proceeds from the sale of the relinquished property to fund the desired improvements or construction. In this case, the exchanger sells the current property and the QI releases money to an EAT for the EAT to buy the replacement property and make the necessary upgrades.  Once complete (must be within the 180 day time period), the exchanger buys the improved property at the higher (improved) value from the EAT. The EAT will be the title holder of the property and will act as construction manager to oversee the previously identified improvements. These transactions can get complicated as it has some of the components of a traditional forward exchange, some of the elements of a reverse exchange with the EAT taking title, and then you add in the management of a construction project. All of this must be completed within the standard 180 day timeline to qualify under section 1031. 
 

The answer is simple. No. There is no limit to how many 1031 exchanges a person can complete.
 

All of the deferred taxes are due to be paid on your personal tax return filed for the year in which you sell a previously exchanged property and don’t complete the sale as a new 1031 exchange. 1031 exchanges are tax-deferred, not tax-free, transactions. There is, however an important exception to this rule and it’s known as “Swap Till You Drop”. If you pass away as the record owner of previously exchanged properties, there will be no capital gains taxes due. That’s because the tax code allows what is called a step up in basis upon the transfer of assets at death. This means that the heirs of the decedent will inherit the property with the cost basis (for tax purposes) being the fair market value at the time of the decedent’s passing, as opposed to using the actual cost basis of the person who passed. While the step up in basis doesn’t apply to possible estate taxes, it will effectively wipe out any capital gains taxes that were previously deferred by the 1031 exchange(s). 
 

A QI is a Qualified Intermediary.  This is a disinterested entity that must be utilized to hold the sale proceeds of the relinquished property in order for an exchange to satisfy the requirements of Section 1031. 

The rules around different owners, can get a bit complicated. The rule is that the owner of the relinquished property must be the same owner as the replacement property. The rule sounds simple on its face, but there are nuances to it. Generally speaking, as long as the two “owners” use the same taxpayer identification number, then it’s acceptable. That means you can sell in your individual name and buy in the name of an LLC, or even certain trusts, so long as they are considered disregarded entities for tax purposes. This is why it’s always a good idea to utilize the services of a trusted and knowledgeable QI. 

No. The properties must be of like-kind, which is defined in the Internal Revenue Code as real property being held for productive use in business or for investment.  Since the enactment of the Tax Cuts and Jobs Act of 2017, 1031 exchanges are widely considered to include only real estate, as opposed to tangible assets.

Typically speaking, the answer is no. There are, however, certain limited circumstances where the sale of a vacation home may qualify for tax-deferred treatment under Section 1031. The property must have been owned for at least two years and, during those two years, the property was rented for fair rental value for at least 14 days per year and was not used for personal use more than 14 days (or 10% of the total rented days if higher than 14) per year. So, while it’s unlikely that a vacation home can be used in a 1031 exchange, it’s good to be aware of these rules as you may be able to accomplish it with some proper planning. Feel free to consult with AMT 1031 for any questions you may have about transferring a vacation home.

A primary residence will not qualify for tax-deferred status under Section 1031 as it’s not property used for business or investment purposes. That being said, the tax code authorizes a $250,000 exemption from capital gains taxes for an individual ($500,000 if a married couple) upon the sale of your primary residence, provided that you meet certain criteria.

In order for the sale proceeds to be fully tax-deferred, you must use ALL of the proceeds toward the acquisition of the replacement property. If you can’t use all of the proceeds in the purchase of the replacement property, however, it does not mean that the entire sale fails. This is referred to as a partial exchange. The portion of the proceeds that met the criteria will be tax-deferred and the remaining proceeds that get released to the exchanger is referred to as boot, and is taxable as capital gains.