Common Questions and Answers about 1031 Tax-deferred Exchanges

Is an exchange really "tax-free"?

A properly executed like/kind exchange results in tax-deferral, which only delays--but does not eliminate--the recognition of taxable gain. However, if replacement property is ultimately inherited by the taxpayer's heirs, they receive a "stepped-up basis", which means that previously-deferred gain is eliminated upon resale.

What if the owner of the property that I want doesn't want my property?

A two-party exchange (a swap) very seldom occurs. However, the 1031 regulations allow you to use a Qualified Intermediary and a Qualified Escrow Holder to execute a delayed exchange, which receives the same tax-deferral treatment as a swap.

Can personal property be exchanged for real property?

Personal property is not like/kind to real property. However, personal property may be exchanged along with real property in a multiple asset exchange. Also, a tax-deferred exchange can be the exchange of personal property for personal property, such as machinery or aircraft.

Can I exchange farm land for an office building on a commercial lot?

Yes, because "like/kind" refers to the nature and character of the property rather than its grade and quality. All types of real estate are considered to be like/kind to all other real estate.

Can I exchange property with a member of my family?

There are specific rules for "related parties", which include being related by family or by business association. Related parties can exchange, but tax rules require that property received from a related party is subject to a minimum two-year holding period.

Can I exchange property with a related party?

Under Section 1031, "related parties" are immediate family members and lineal descendants as well as entities with which the taxpayer has common ownership of more than 50 percent. If a taxpayer sells relinquished property to a related party, the related party must hold the property for at least two years. For the acquisition of replacement property from a related party, there has been authority issued from the IRS that implies some serious restrictions on such exchanges. Any taxpayer considering a related party exchange should seek competent tax counsel before proceeding.

Is there a limit on the number of exchanges I can do in one year or in a lifetime?

The IRC does not limit the number of exchanges a taxpayer can do.

What is the basis of the replacement property?

The replacement property takes a transferred/carry over basis from the relinquished property. That's how the capital gains are deferred.

If I receive some cash when I transfer my relinquished property, can I still get 1031 tax-deferred treatment for the transaction?

If you receive "boot" (cash or non-qualifying property) in the exchange in addition to the like/kind property and the exchange otherwise qualifies, gain will be recognized only in the amount of boot received.

Can I purchase a property expressly for the purpose of using it as a relinquished property?

No. Doing so violates the requirement that relinquished property be "held either for productive use in a trade or business or for investment".

What if I plan to sell the replacement property right after the exchange?

The exchange will probably fail because replacement property must be "held either for productive use in a trade or business or for investment".

What if I have several properties I want to exchange?

You can do several different exchanges and relinquish one property in each exchange, or you can relinquish more than one property in a single exchange. There is no limit on the number of properties to be relinquished or acquired in an exchange.

Can I decide to do a tax-deferred exchange after I transfer title to a property?

The intent to exchange should be clear from the beginning of the transaction. However, a taxpayer can decide to exchange property any time prior to the actual transfer of the relinquished property. Once that transfer has occurred, if you are in receipt of the sales proceeds and proper exchange documentation has not been executed, the transfer of the relinquished property must be treated as a taxable sale.

If the proceeds from the transfer of my relinquished property are deposited with a Qualified Escrow Holder, can I still borrow against them?

No. The Agreement between you and the Qualified Escrow Holder must provide that you do not have any right to receive, pledge, borrow or otherwise benefit from the funds being held by the Qualified Escrow Holder.

When I calculate the 45-day Identification Period and the 180-day Exchange Period, can I exclude weekends and holidays?

These periods are based on calendar days and must include weekends and holidays. Also, if either period ends on a Saturday, Sunday, or holiday, the period is not extended for a day.

If I transfer my replacement property at the end of a calendar year, it will shorten my Exchange Period. Can I apply for an extension of the Exchange Period?

No. The Exchange Period expires at midnight the earlier of 180 days after the transfer of the relinquished property or the due date of the taxpayer's tax return for the year in which the relinquished property was transferred. However, you can apply for an extension of your tax return due date, and that will extend your Exchange Period to the full 180 days.

How many replacement properties can I identify?

The number of replacement properties that can be identified are limited by: 1) the Three-property Rule; 2) the 200 Percent Rule; and 3) the 95 Percent Rule. Also, any replacement property that is acquired before the end of the 45-Day Identification Period is deemed to be "identified".

Can I replace relinquished property with replacement property that doesn't yet exist?

Yes, it is possible to designate real property to be built or produced as replacement property, provided it is described in sufficient detail. The replacement property must be constructed on land not already owned by the taxpayer.

Do I have to use a Qualified Intermediary in order to do a deferred exchange?

The use of a Qualified Intermediary is just one of four Safe Harbors that the IRS has designed to guard against the taxpayer's receipt of cash proceeds before the exchange is completed. However, a four-way exchange in which the taxpayer relinquishes property to one party and buys property from another party requires the use of a Qualified Intermediary to satisfy IRC Regulations.

Can I acquire a replacement property before I transfer my relinquished property?

A taxpayer can contract for the purchase of replacement property before transferring the relinquished property, but cannot actually take title until he or she has closed on the sale of the relinquished property. What you are describing is known as a "reverse exchange", and there are no means specified in the 1031 Regs to structure an exchange in this reverse manner. Iowa Exchange can help you work through the details of setting up a "reverse exchange".

Who cannot act as the taxpayer's Safe Harbor?

Anyone who is an agent or employee of the taxpayer (such as the taxpayer's attorney, accountant, broker or investment banker), related to the taxpayer or related to an agent of the taxpayer. These are all disqualified persons.

If I use a Qualified Intermediary in a four-way exchange, does the Qualified Intermediary have to take title to the relinquished and replacement properties?

No, the IRS regulations make it clear that you can "direct deed" from the taxpayer to the buyer of the relinquished property and from the seller of the replacement property to the taxpayer as long as exchange documentation is provided.

Can I use a 1031 tax-deferred exchange on property that has been condemned?

No, because Section 1033 of the IRS Code has mandatory treatment for property that is the subject of involuntary conversion due to condemnation or casualty loss. Consult your tax advisor on the mechanics of a Section 1033 exchange.