1031 Tax-Deferred Exchanges: Building Wealth through
Real Estate
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§1031 Tax-Deferred Exchanges: Building
Wealth through Real Estate
Qualifications for a “Like-Kind” Exchange
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Learning Objectives
Upon completion of this webinar you will be able to:
• Define the "Like-Kind" exchange & requirements for tax-deferred exchange.
• List the steps involved in properly executing a Sec 1031 tax-deferred "likekind" exchange.
• Identify types of real estate properties such as principal residence,
investment properties, vacation homes, and which qualify for a tax-deferred
exchange.
• Define the rules for identifying replacement property.
• Identify special circumstances of exchanges.
• Identify who can serve as a qualified intermediary.
• Determine what is a related party exchange and who is a related party.
• Identify problems with related party exchanges.
• Determine qualifications of vacation home properties.
• Recognize disaster area extensions.
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§1031 Tax-Deferred Exchanges
Tax-deferred exchange allows you to preserve your wealth
through reinvestment in “like-kind” assets.
A tax-deferred exchange allows for deferral of capital gains
taxes if structured correctly.
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The Concept of “Like-Kind”
Any real or personal property can be exchanged, provided it
is held for
“Productive use in a trade or business” or
For investment, and
Is exchanged for “like-kind” property that will be held for
the same purpose
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What is “Like-Kind”?
Like-kind does not mean exactly the same
Single family rental unit may be exchanged for other real
property such as
Warehouse, retail center, office building, farm property,
leasehold interest in real estate
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What is “Like-Kind”?
Most real property is “like-kind” to other real property.
Real property is not “like-kind” to personal property.
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“Like-Kind” Exchange Example
You acquired an improved property for $800,000 four years ago.
Current mortgage balance is $600,000
Property has appreciated to $1,800,000
Depreciation deductions of $100,000
$175,000 Capital Gains taxes if sold
No Capital Gains taxes if deferred-exchange
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“Like-Kind” Exchange Example
SALE
EXCHANGE
Current Value
$1,800,000
$1,800,000
Mortgage Payoff
$(600,000)
$(600,000)
Tax on $1,000,000
Appreciation @ 15%
$(150,000)
Deferred
Tax on $100,000
Depreciation Recapture @
25%
$(25,000)
Deferred
Available for Reinvestment
$1,025,000
$1,200,000
Value of Replacement
Property 30% Down
$3,416,667
$4,000,000
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Requirements for Tax-Deferred Exchange
Identification period
Exchange period
Fully deferred exchanges
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Identification Period
Replacement property must be identified within 45 days of
the transfer of the relinquished property.
Deadline can not be extended for weekends or holidays.
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Exchange Period
Acquisition of replacement property must be completed by
the earlier of
180 days of the transfer of the relinquished property, or
The due date of filing your federal tax return for the year in
which property was relinquished (includes extensions).
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Fully Deferred Exchanges
Exchange will be fully tax-deferred only if
Replacement property is equal to or greater in value and
equity than your relinquished property
Debt of your replacement property must also be equal to or
greater than debt on relinquished property unless cash is
added to offset debt
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Rules for Identifying Replacement Property
3-Property Rule (Three properties regardless of value), or
200 Percent Rule (Any number of properties, as long as
combined FMV doesn’t exceed twice the value of relinquished
property), or
95 Percent Rule (Any number of properties, regardless of
combined FMV, as long as you acquire 95% or more of the
total value of properties)
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1031 Exchange Process
Use a “Qualified Intermediary” to ensure a successful and
smooth transaction
Use a reputable and knowledgeable realtor
Use a “real estate” attorney experienced with 1031
exchanges
Allow sufficient time to complete entire real estate
transaction
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1031 Exchange Process - Step 1
Purchase Contract –Relinquished Property
The contract between you and your buyer should contain a
“cooperation clause”
Cooperation clause should state that buyer agrees to an
assignment of the contract by the seller to the QI
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1031 Exchange Process – Step 2
Exchange Documentation
Contact the Qualified Intermediary (QI) to start tax-deferred
exchange process
QI will prepare exchange agreement,
Assignment of the relinquished property purchase contract,
Notice of the assignment, and
Instructions to the settlement agent
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1031 Exchange Process – Step 3
Closing the relinquished property
Property will be conveyed to buyer
Cash proceeds from sale must be delivered to the QI.
You should never be in either actual or constructive receipt of
the cash proceeds
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1031 Exchange Process – Step 4
Investment of cash proceeds & identification forms
After closing of relinquished property the QI will hold the
proceeds, and
Provide you with forms to identify replacement properties within
the 45 day identification period
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1031 Exchange Process – Step 5
Purchase Contract–Replacement Property
Enter into purchase contract with seller
Replacement property purchase contract should have
“cooperation clause”
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1031 Exchange Process – Step 6
Exchange Documentation
Qualified Intermediary will prepare
Assignment of the replacement property purchase contract
(assign rights to QI)
Notice of the assignment (deliver to seller)
Instructions to the settlement agent
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1031 Exchange Process – Step 7
Closing the Replacement Property
Qualified Intermediary delivers exchange proceeds to
purchase replacement property
Seller will convey replacement property
Closing must occur by 180 days from date of closing of
relinquished property, or due date of filing federal tax return
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1031 Exchange Process – Step 8
Completion of Your Exchange
Qualified Intermediary provides you all the exchange
documents including proof of
Receipt and disbursement of all exchange funds
Complete Form 8824 to file with tax return
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Why Do I Need a Qualified Intermediary?
A QI is necessary to create the exchange correctly
It requires experience, special knowledge, and extreme care
to preserve the tax-deferred character
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Can Anyone Serve As a QI?
Absolutely Not!
Relatives, or anyone who within a two year period prior to the
exchange has acted as your
Attorney, accountant, real estate broker, or agent
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What Characteristics Should A QI Have?
Experience
Financial Stability
Customer Satisfaction
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If I Have a QI Do I Need A Legal or Tax Advisor?
Yes, Absolutely!
Your QI will carry out the exchange and prepare necessary
documentation for tax deferral
Your QI does not offer tax advice
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How Do I Identify Replacement Property?
Identification of replacement property must be
submitted in writing
Unambiguously described,
Signed by you,
Delivered or sent before midnight of the 45th day
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What If I Want To Cancel My Exchange?
If you cancel after the QI receives your cash proceeds, certain
restrictions apply that limit access to your cash until certain
time periods elapse
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What If I Sell A Property & Decide To Do A TaxDeferred Exchange?
You might be Out of Luck!
If you actually or constructively receive proceeds from
the sale, you can’t participate in a tax-deferred
exchange
If you have not closed on the sale you may be able to
do a tax-deferred exchange
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What Is Boot?
“Boot” can be cash received from the sale of the
relinquished property, or
Other non-cash consideration, including property that
is not “like-kind”, or
Promissory notes, or
Debt relief (mortgage boot)
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Do I Need To Do A Tax-Deferred Exchange For My
Personal Residence?
NO, Principal residence is not considered property held “for
productive use in a trade or business”, or “for investment”
Principal residence gains can be excluded under Code Section
121
$250,000 exclusion for single taxpayer
$500,000 exclusion for married couple filing joint
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Review Questions for Self-Study CPE
Now’s the time to answer the review questions.
Follow this link:
http://www.proprofs.com/quiz-school/story.php?title=NTc1NzMz
Please leave quiz window open and wait to submit until prompted to
complete questions 4 through 6. Once completed, press Submit and
close quiz window.
Same Taxpayer Requirement
Replacement property must be held in same manner as the
relinquished property
A single-member LLC that elects taxation as a sole proprietorship
as the single member are treated as one and the same taxpayer
A grantor trust (revocable living trust) and the grantor are
treated as one and the same
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Like-Kind Requirement
Only “like-kind” property qualifies for replacement property
All real property is considered like-kind to all other real
property
Regardless if property is improved or not
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Fully Deferred Exchange
Replacement property must be equal to or greater in value than
relinquished property
Must reinvest all equity from the relinquished property
Acquire only like-kind property
Any cash pulled out (including initial down payment) will be
treated as taxable boot
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Receipt of Boot
Cash and other non like-kind property received in an
exchange, or
Debt that is paid off on the relinquished property and not
replaced with equal or greater amount of debt on new
property is
Considered “boot” and taxable up to amount of gain
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Reverse and Improvement Exchanges
Reverse exchanges are available for taxpayers who need to
acquire replacement property before transferring the
relinquished property, or
If exchanged proceeds are to be used to make improvements
to targeted replacement property
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What Is A Related Party Exchange?
A 1031 exchange where either buyer of the relinquished
property, or
Seller of the replacement property (or both) is “related” to the
investor doing the exchange
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Related Parties
Property may be transferred to a related party as long as
related party holds the property for two years
May not acquire a replacement property from a related party
if the related party receives cash from the transaction
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Who Is A Related Party?
Related party includes family members such as:
Spouses
Brothers
Sisters
Ancestors (parents & grandparents)
Lineal descendants (children & grandchildren)
Corporation or partnership and a person who owns more than
50% interest in the entity
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What’s The Problem With Related Party Exchange?
Related party exchanges can encourage abusive basis shifting
IRS gives related party exchanges special scrutiny
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Swapping With A Related Party
Each related party must hold their replacement property for at
least two years after the last transfer occurs in the exchange
If either party transfers their property before the two year
holding period, both parties exchanges will be disqualified, and
Gain must be recognized on each of the original transfers, as
of the date of disposition of property
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Selling To A Related Party
IRS has issued private letter rulings holding that two year
requirement does not apply when
The investor uses a QI and sells to a related party, but acquires
new property from unrelated party
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Buying From A Related Party
If investor acquires replacement property from a related party
and sells relinquished property to unrelated third party,
IRS will likely scrutinize and disqualify exchange because of
potential basis shifting
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Exchanging Fractional Interest In Multiple Parcels
Related parties may exchange fractional interests in multiple
parcels
IRS has ruled these types of exchanges to be valid
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Can I Exchange My Vacation Home?
Property held for personal use does not qualify
Must be able to prove investment use
Appreciation is not sufficient to prove investment
intent
Barry E. Moore vs. Commissioner
T.C Memo 2007-134
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IRS Safe Harbor – Rev. Proc 2008-16
In 2007 the Treasury Inspector General for Tax Administration
issue a report recommending additional oversight of like-kind
exchange
In response IRS issued Rev. Proc 2008-16 providing a safe
harbor
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Qualifying Under Rev. Proc 2008-16
Properties must be owned for at least 24 months before and
after the exchange
During each 12 month period both properties must be rented at
FMV for 14 days or more
Personal use cannot exceed the greater of 14 days or 10% of the
days during each 12 month period the property was rented at
FMV
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Qualifying Under Rev. Proc 2008-16
“Personal Use” is not limited to use by the taxpayer. Includes use
by:
Taxpayer’s family members,
Any other person with an interest in the unit, or their families,
Anyone using the unit under an arrangement allowing taxpayer
to use some other dwelling, or
Anyone, if property is rented for less than FMV
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Qualifying Under Rev. Proc 2008-16
Keep personal use limited to greater of 14 days or 10% of rental
period
Rent property to unrelated party for at least 14 days per year. No
need to rent for more than 14 days
Treat property as investment by deducting expenses for
maintenance, insurance, utilities, and depreciation.
Structure mortgage loan as investment loan and not for primary
residence
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Real Estate Outside the U.S.
Real estate outside the U.S. is not like-kind to real estate in
the 50 states
You can exchange foreign for foreign real estate
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1031 Treatment for Conservation Easements
Sale of an entire fee interest in land held for investment would
qualify for 1031 exchange
IRS has issued private letter rulings finding that certain
conservation and agricultural easements are like-kind to real
estate
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Extensions for Disaster Areas
 Rev. Proc 2007-56 allows the 45 and 180 day deadlines to be
extended to 120 days from such deadline for Covered Disaster
Areas
1) Taxpayer must be located in Covered Disaster Area
(relinquished or replacement properties don’t need to be in
disaster area)
2) Relinquished property should be transferred on or before the
listed disaster date
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Extensions for Disaster Areas
As of March 12, 2012 Covered Disaster Areas include
Massachusetts and Rhode Island
As of March 23, 2012 includes Mississippi
As of April 24, 2012 includes Alabama
As of April 30, 2012 includes Tennessee
As of May 12, 2012 includes Kentucky
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Extensions for Disaster Areas
 As of February 10, 2013 includes Mississippi
As of April 16, 2013 includes Illinois
As of May 2013 includes Oklahoma
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Dodd-Frank Wall Street Reform Act
On July 21, 2010 President Obama signed the Dodd-Frank Wall
Street Reform and Consumer Protection Act
Title X of the Act created a new agency “Bureau of Consumer
Financial Protection” which will regulate Qualified
Intermediaries
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Revenue Procedures
March 2010 – Rev. Proc 2010-14 (Insolvency issues of a QI)
Nov 2008 – Rev. Proc 2008-16 (Safe harbor for vacations and
second homes)
Jan 2009 – Rev. Proc 2007-56 (Clarifies who is eligible for an
extension of 45 and 180 days)
Nov 2008 – Rev. Proc 2000-37 (Provides guidance on structuring
reverse 1031 exchanges)
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Private Letter Ruling 201048025
Issued December 3, 2010
Ruling made Section 1031 available to taxpayer, related party,
and affiliates providing each party holds their replacement
property for two years
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Revenue Ruling 90-34
Ruling allows direct transfers of like-kind property
Seller who sells like-kind property to investor does not have to
receive or hold title to property being transferred to investor
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The Rich’s 1031 Exchange
Don and Susan Rich own 3 beachfront condos in Destin, FL (Unit
7, 8, 9)
All 3 units were purchased in 2002
Unit 7 (1 bed/1 bath) and Unit 8 (2 bed/2 bath) are actively
rented
Unit 9 (2 bed/2 bath) is the Rich’s second home. It was has never
been rented
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The Rich’s 1031 Exchange
Basis in Unit 7 is $90,000
Basis in Unit 8 is $235,000
Basis in Unit 9 is $235,000
Unit 7 has suspended losses of $110,000
Unit 8 has suspended losses of $105,000
All 3 units are under contract to sell for $658,000
Replacement property a single family home is under contract for $580,000
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The Rich’s 1031 Exchange
Do the 3 units qualify for 1031 exchange?
What would you recommend to the Rich’s? Why?
63
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