What is a 1031 exchange?

A 1031 exchange is an important tool that real estate investors can use to defer capital gains taxes on their properties. Investors can diversify their holdings and obtain better investment properties because 1031 exchanges allow investors to use the full power of their equity without being subject to taxation.

What is a “qualified intermediary”?

A qualified intermediary or “QI” (also known as an exchange accommodator or facilitator) is an individual who enters into an agreement with a taxpayer to complete a 1031 exchange. The QI acts as the driver of the exchange and holds the exchange funds on behalf of the taxpayer. The QI also works closely with the individuals involved in the transaction (realtors, title company employees, attorneys, etc.) to ensure proper transfer of all properties involved in the exchange.

A number of people CANNOT act as your QI. These include yourself, your real estate agent, your attorney, your CPA/accountant, or your securities broker. Additionally, your title/escrow company cannot simply hold the funds in escrow for you. You must enter into a written agreement with a QI in order to have a valid exchange.

Qualified intermediaries are not nationally licensed or extensively regulated in most states. It is very important to choose a QI that is knowledgeable, stable and diligent. Land Title Exchange Corporation is your best choice for a qualified intermediary.

Which types of property can qualify for a 1031 exchange?

A property or properties held for productive use in a trade or business or for investment can be eligible for a 1031 exchange. You may sell an eligible property and purchase property of “like-kind.” In the context of a 1031 exchange, “like-kind” is very broad and means that any type of investment property may be exchange for any other type of investment property. Both properties must be located in the United States. For example, this means you may trade a single-family residential rental for commercial property. Or you may exchange commercial property for vacant land.

Which types of property DO NOT qualify for a 1031 exchange?

Primary residences should never be bought or sold as part of a 1031 exchange. Second homes or vacation homes may qualify in limited circumstances, so please call us for further info if this applies to your situation. Partnership shares, stocks, bonds, certificates or trust, or similar types of property, are also excluded from 1031 exchanges. “Fix-and-flips” as well as properties that are held as inventory do not qualify for 1031 exchanges.

How much time do I have to complete my exchange?

There are two major deadlines involved when completing an exchange: the 45 Day Identification period and the 180 Day Exchange Period. A taxpayer must identify replacement properties to his/her qualified intermediary within 45 days after the closing of the relinquished property. And all replacement properties must be purchased and closed within 180 days of the sale of the relinquished property.

Can I buy my replacement property before selling my relinquished property?

Yes, this is possible through a reverse 1031 exchange. However, LTEC does not facilitate reverse 1031 exchanges. We can provide you with limited info and references for reverse 1031 exchange accommodators.

If I want to cancel my exchange or I won’t be able to complete my exchange, when can I get my money back?

The IRS has strict limits on when a taxpayer may receive the exchange proceeds. A taxpayer may never receive funds back prior to the expiration of the 45 day identification period. Once this period ends, there are two scenarios when the taxpayer may receive their funds back:

(1) The receipt by the taxpayer of all of the replacement property to which the taxpayer is entitled under the exchange agreement.

For example, Mary sold her rental house and identified a condo unit that she wants to purchase and rent. Mary closes her purchase of the condo, but she still has $1,000. left over in her exchange account. Mary may receive her funds back after closing on the condo purchase because she has closed on all properties that she identified during the 45 day identification period.

But suppose Mary identified two condos, purchases one, and still has $1,000. left in her account. She does not want to purchase the second condo on her list. LTEC would not be able to return her funds until the 180 day exchange period ends, because she has not closed on all identified properties. Mary may also declare on her identification form that she only intends to purchase one of the properties on her list. This would allow LTEC to return the excess funds after she completes her first/only purchase. LTEC’s identification form is set up for a taxpayer to declare how many of the identified properties he or she wishes to purchase.

(2) The occurrence after the end of the identification period of a material and substantial contingency that

(a) Relates to the deferred exchange,
(b) Is provided for in writing, and
(c) Is beyond the control of the taxpayer and of any disqualified person, other than the person obligated to transfer the replacement property to the taxpayer.

This second scenario is very limited. Essentially, an event must occur that makes the proposed transaction impossible, and that event must be outside the control of the taxpayer. A common example is when a proposed transaction requires the issuance of a permit or zoning change by a government entity. If the government entity cannot or will not grant the needed permit or change, then the taxpayer may be able to rely on that denial as a basis for ending the exchange. But if a taxpayer simply wants to end the exchange because he/she cannot get an accepted purchase offer, then this option is not available.

*Denver Realty Pro would like to credit Land Title Guarantee Company for the content on this page. This information is not intended to replace qualified legal and/or tax advice. If you have questions, please seek professional legal and tax services.