We have recently received calls and e-mails from our Miami investor clients, asking about 1031 exchanges. So I decided to explain it in a brief and hopefully understandable way. We always recommend that you contact and attorney and/or CPA, and we're here to help you with the Miami properties when you are ready.
What is an IRC 1031 Tax Deferred Exchange?
A 1031 Exchange, is a transaction which specifies if an asset (usually some form of real estate such as land or a building) is sold and the proceeds of the sale are the reinvested in an asset of a similar kind, therefore no capital gain or loss is recognized, allowing the deferment of capital gains taxes that would otherwise have been due on the first sale. The actual law is Title 26, section 1031 of the Internal Revenue Code.
In plain English, this means that a 1031 Exchange is a rollover of equity of like properties, rather than an avoidance of tax.
There are 3 important parts that are important for a smooth and successful 1031 Exchange:
1. Time Requirements
2. Identification Rules
3. Monetary Requirements
There are two time requirements: identification period and exchange period which total 180 days.
- 45 day period to identify specific properties as potential replacements.
- 45 day clock starts when the relinquished property is settled. (the day the first property closes)
- Three rules for declaring potential replacement properties (See Identification Rules)
- Begins on the date the taxpayer transfers (closes) the sale of the relinquished property and ends at midnight of the 180th day.
- There are no extensions for the 45th or the 180th day and there are no extensions for Saturdays, Sundays, or Holidays.
**UPDATED** Exchanger may need to file an extension on their tax return if the replacement property is not closed in time to file yearly taxes.
- Three Property Rule - The exchanger may identify three (3) properties of any value
- 200% Rule - The exchanger may identify any number of properties if the total fair market value of what is identified does not exceed 200% of the sale price of the relinquished property; or (i.e. relinquished property sold for $200,000 - identified properties cannot be more than $400,000)
- 95% Rule - If the exchanger identifies more properties than are permitted under the two rules above, the exchanger must acquire 95% of what was identified. (Be care careful with this one ;) )
There are three monetary requirements which dictate whether or not a transaction qualifies as a 1031 Exchange:
All three of these amounts for the relinquished property must be equal to or greater than these amounts for the replacement property. If not, some amount of capital gains taxes and /or depreciation taxes will apply.
There are many other things to consider when doing a 1031 exchange. Every transaction is different so be sure to consult your attorney and/or CPA to see if a 1031 exchange is right for you.
*edit from June 2008 article*