Equicap 1031 Exchange

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FAQs

Any property held for productive use in a trade or business or for investment can be exchanged for like-kind property. Like-kind refers to the nature of the investment rather than the form. Any type of investment property can be exchanged for another type of investment property. A single-family residence can be exchanged for a duplex, raw land for a shopping center, or an office for apartments. Any combination will work. The exchanger has the flexibility to change investment strategies to fulfill their needs.

You cannot trade partnership shares, notes, stocks, bonds, and certificates of trust or other such items. You cannot trade investment property for a personal residence, or houses built by a developer and offered for sale are stock in trade. If an investor buys “fixer-uppers” and sells them as soon as they are improved, the properties may be considered as stock in trade and cannot be exchanged.

If we find the asset being relinquished does qualify for a 1031 Exchange, the next question is what the replacement property will be. As discussed previously, section 1031 applies to both “real property” and “personal property.” The primary difference between a personal property exchange and a real property exchange is the definition of like-kind.

Property held for productive use in a trade or business or for investment qualifies for a 1031 Exchange. The tax code specifically excludes some property even if the property is used in trade or business or for investment. These excluded properties generally involve stocks, bonds, notes, securities and interests in partnerships.

Property held “primarily for sale” is also excluded. This excluded property would include business inventory. For real estate, it means property purchased with the intent to sell it, such as a fixer-upper or vacant land to be developed into a house. An investor who “turns” residential properties, or a private developer, may be classified as dealer.

A primary residence usually does not qualify for an exchange because it is not used in trade or business or investment. That said, that portion of the primary residence that is used in a trade or business or for investment may qualify for a 1031 Exchange.

The answer is “yes” if the dwelling meets the qualifications set forth in Revenue Procedure 2008-16. Effective March 10, 2008. This revenue procedure clarified what was once considered a muddled area of 1031 exchanges. The qualifications are the following: Relinquished property 1. The holding period for the vacation home is at least 24 months immediately before the exchange*; 2. For each of the two-12-month periods, the vacation home is rented to another person at a fair rental for 14 days or more; and 3. The homeowner limits his use of the vacation home to not more than 14 days or 10% of the number of days during the 12-month period that the vacation home is rented at a fair rental value. * For this purpose, the first 12-month period immediately preceding the exchange ends on the day before the exchange takes place (and begins 12 months prior to that day) and the second 12-month period ends on the day before the first 12-month period begins (and begins 12 months prior to that day). p>Replacement property 1. The holding period following the exchange is at least 24 months*; 2. For each of the two-12-month periods, the vacation home is rented to another person at a fair rental for 14 days or more; and 3. The homeowner limits his use of the vacation home to not more than 14 days or 10% of the number of days during the 12-month period that the vacation home is rented at a fair rental value. * For this purpose, the first 12-month period immediately after the exchange begins on the day after the exchange takes place and the second 12-month period begins on the day after the first 12-month period ends. Here’s an example to analyze this revenue procedure. Let’s assume that taxpayer has owned a beach home since July 4, 2002. The taxpayer and his family use the beach home every year from July 4, until August 3 (30 days a year.) The remainder of the year the taxpayer has the house available for rent. Now, the taxpayer has negotiated the sale of his beach home so that ownership of the house transfers on May 5, 2008. Under the Revenue Procedure, the IRS will examine two 12-month periods: (1) May 5,2006 through May 4, 2007 and (2) May 5, 2007 through May 4, 2008. To qualify for the 1031 exchange, the taxpayer was required to limit his use of the beach house to either 14 days (which he did not) or 10% of the rented days. So, the IRS will need to find that the taxpayer actually rented the house at a fair market value for 300 days each during the two 12 month periods for the vacation home to qualify for a 1031 exchange. As always, your CPA and/or attorney can advise you on this tax issue.

Getting started with an exchange is as simple as calling your Exchange Facilitator. Before making the call, it will be helpful for you to have information regarding the parties to the transaction at had (for example, names, addresses, phone numbers, file numbers, and so on). During the phone call, the exchange coordinator will ask questions about the property being relinquished and any proposed replacement property.

The initial discussion will vary dramatically from company to company with respect to the amount of detail requested. There is very little actual information required to structure a basic delayed exchange. We at Equity Advantage take a more in-depth approach to the process; we like a proactive rather than reactive position. The more we understand our client’s objectives, the better equipped we are to help them achieve them. For this reason, we encourage our prospective clients to both ask questions and answer ours.

In preparation for your exchange, contact an exchange facilitation company. You can obtain the names of facilitators from the internet, attorneys, CPAs, escrow companies or real estate agents. Facilitators should not be acting as “agents” as well as facilitators. Escrow companies, attorneys, real estate agents, etc. are agents and should not be used as facilitators. Ask questions about the procedures employed and the assistance they can provide if problems arise. Price, though important, should not be the qualifier. Exchange fees typically range from $400 to $750, the difference in price often reflecting a difference in service. You may wish to obtain copies of the documents the facilitator will use for review by your attorney.

From the time of closing on the relinquished property, the investor has 45 days to nominate potential replacement properties and a total of 180 days from closing to acquire the replacement property. Identification requirements: The investor must identify the replacement property prior to midnight on the 45th day. The investor normally nominates three potential properties of any value, and then acquires one or more of the three within 180 days. Typically, a common address or an unambiguous description will suffice. If the investor needs to identify more than three properties, it is advisable to consult with your 1031 facilitator.

As an Exchangor, you are required to provide an “unambiguous description” of the potential replacement property on or before the 45th day after closing on the relinquished property. (A legal description or property address will suffice). If you wish to identify or purchase multiple properties, you must follow one of the following guidelines:

1. Identify up to three properties of any value with the intent of purchasing at least one.

2. Identify more than three properties with an aggregate value that does not exceed 200% of the market value of the relinquished property.

3. Identify more than three properties with an aggregate value exceeding 200% of the relinquished property, knowing that 95% of the market value of all properties identified must be acquired.

An exchange is not an “all or nothing” proposition. You may proceed forward with an exchange even if you take some money out to use any way you like. You will, however, be liable for paying the capital gains tax on the difference (“boot”).

Typically the only information we require in order to structure your exchange is the following:

The Exchangor’s name, address and phone number
The escrow officer’s name, address, phone number and escrow number

With this said, the following is a list of information we would like to have in order to thoroughly review your intended exchange:

1. What is being relinquished?

When was the property acquired?

What was the cost?

How is it vested?

How was the property used during the time of ownership?

Is there a sale pending? If so, what is the closing date?

Who is closing the sale?

What are the value, equity and mortgage of the property?

2. What would you like to acquire?

What would the purchase price, equity and mortgage be?

If a purchase is pending, who is handling the escrow?

How is the property to be vested?

It does not matter how many properties you are exchanging in or out of (1 property into 5, or 3 properties into 2) as long as you go across or up in value, equity and mortgage. The only concern with exchanging into more than three properties is working within the time and identification restraints of section 1031.

The tax code does not provide a specific time period for holding investment property. Time is less important than the investor’s intent at the time of acquiring the property (that is, did the investor intend to hold the property as an investment).

Often times, people have the general understanding that there is a one-year hold period for an exchange. The reason for this general consensus is that the government has proposed a one-year hold period several times. An additional indication that the IRS may like to see the one-year time period is that the tax code differentiates a long-term capital gain from a short-term capital gain at one year. Again, there is not a tax code mandate of one year, but it may be that the IRS would like to see at least a one-year hold. The only minimum required hold period in section 1031 is a “related party” exchange where the required hold is a minimum of two years.

A related party transaction is allowed by the IRS, but significantly restricted and scrutinized. The purpose for the restrictions is to prevent Basis Shifting among related parties. Using a third party to circumvent the rules is considered to be a Step Transaction and is disallowed. If your transaction is audited, the IRS will look at the chain of ownership for the property. The definition of a related party for 1031 purposes is defined by IRC 267b. Related Parties include siblings, spouse, ancestors, lineal descendants, a corporation 50% owned either directly or indirectly or two corporations that are members of the same controlled group.

The restrictions vary depending on whether you are buying from or selling to a related party. The following lists guidelines for each.Investor selling investment property to a related party:

  • 2-year holding requirement for both parties.
  • Does not apply where related party also has 1031 Exchange; death; involuntary conversion.
  • 2 years are tolled during the time there is no risk of loss to one of the parties (put right to sell property/call right to buy property/short sale).


Investor buying investment property from a related party:

  • Related party must also have a 1031 Exchange; or
  • Taxpayor’s deferment of capital gain is less than or equal to seller’s taxable gain from selling the property.

A successful 1031 Exchange requires that property be exchanged. Contractual rights and obligations pertaining to real property may or may not be characterized as a property interest and may or may not be eligible for an exchange.

A working interest is considered a real property interest, whereas a royalty interest is not. What is the difference? It is the Exchangor’s rights and obligations to access the property. A working interest is the exclusive right to enter land and extract oil, gas and minerals. It involves the right and cost obligation to explore, drill and develop the oil, gas and minerals. It also carries the obligation of paying for operating expenses. In contrast, a royalty interest allows for a percentage share of production only. There is not any obligation for development or operating expenses. As such, this interest is not considered a real property interest, but rather payment for services.

Clearly, a working interest in gas, oil and minerals may be exchanged to a different working interest in gas, oil and minerals, but what about other type of exchanges? Just as real estate properties can be exchanged as “like-kind” even though the properties are not exactly the same (for example, an apartment complex for a vacant lot), the same may be true for property rights, such as the rights to oil, gas and minerals. So, depending upon the particulars of the property, a working interest in oil may be exchanged for a rental house. In contrast, a royalty interest cannot be exchanged for a working interest.

Water rights (the right to access and receive water) and timber rights (the right to enter land and cut down timber) are generally characterized in the same manner as oil, gas and mineral rights. It should be noted, however, that these rights are characterized according to state law. For example, the State of Oregon characterizes that the right to cut standing timber is personal property, whereas the State of Georgia characterizes it as real property.

It is possible to cancel an exchange but the cost and timeframe in which you can terminate a deal varies from facilitator to facilitator. The issue with exchange termination is the constructive receipt concept. Section 1031 requires the taxpayor not have actual or constructive receipt of the exchange proceeds. If a taxpayor can simply ask for and receive the funds at anytime, the exchange procedure may not be defendable.
Therefore, it is possible to terminate an exchange at the following times:

  1. Anytime prior to the close of the relinquished property sale.
  2. After the 45th day and only after you have acquired all the property you have the right to acquire under section 1031 rules.
  3. After the 180th day.


Please contact us directly if you have additional questions in regards to canceling your exchange.