Mortgage Transfer
Mortgage Transfer

1031 Exchanges are tax-deferred exchanges for real estate. As a Nevada Real Estate agent we do these types of transactions all the time. It gets its name from Section 1031 in the IRS code. A lot of people think and say that it's a tax-free exchange. Eventually, the gain and the depreciation recapture has to be paid.

The 1031 exchange has been around in one form or another since 1922. It's nothing new. There are just more rules now than there were back then. Here are the seven things you need to know about 1031 exchanges. This covers about 90% of the things you really need to know. The other 10% are just small details.

What is a 1031 Exchange?

Number one, what is a 1031 exchange? Well, I touched on it a little already. It is when you sell a property that's held for investment and want to defer the capital gains and not recapture the depreciation you have taken on the property. As long as you follow these rules, you'll be fine. 

Real Property Use

Rule number two, is real property use. Both what you are selling, and what you want to buy, must be property held for investment. You cannot use your personal house, but you can do a rental house, an office, industrial building, investment land or retail building. It doesn't have to be the same type so you could sell an apartment building and buy a shopping center. You can sell land held for investment and buy an office building. Whatever the property type it has to be held for investment purposes.

45 Day Identification Period

Rule number three, is an important one. The 45-day identification period. This is an absolute rule that must be followed and is set in stone. When you close on the property that you are selling, you have to identify a list of replacement properties and submit it to the qualified intermediary within 45 days so your exchange can qualify. In the identification rule, you have three types. The first one is the most common and that's where you identify up to three properties. Nice and simple. The second way is the 200% rule. That means that all the properties that you identify, the value has to be no more than 200% of the property that you are selling. The third rule, which really isn't used a lot, is the 95% rule. That means you can identify as many properties as you want, but you have to buy 95% of the ones that you identify. As I mentioned, it's not used a lot.

180 Day Rule

Rule number four, the 180 day exchange rule. You only have 180 days from the time you sell the property to close on the properties that you have identified to purchase. That number is also set in stone. If it's the 180the day is on a Saturday or a Sunday or a holiday, though. You've got to close before that because you can't go past. There are no exceptions.

Qualified Intermediary

Number five, qualified intermediary, or QI. You must use a QI to do the paperwork and hold the money from your sale. You cannot touch or receive the money from your sale or your 1031 is disqualified. The QI, according to the IRS, must be an unrelated party to the transaction. So your attorney cannot hold the money. Your accountant cannot hold the money. It has to be unrelated. A neighbor, but I'm not sure you'd want to have your neighbor hold the money. We use a lot of national companies that have $100 million dollar bonds to cover that money they hold. Some attorneys charge 2,500 to $3,000 to do a 1031 exchange. Some of the national companies that we use are under a $1000. They do everything, the paperwork, they deal with the title companies, very painless and you know, it's going to be done right?

Proper Title Holding

Rule number six, proper title holding. If you own the property in a name like John Smith, the new property has to be titled the same way, John Smith. It cannot be John and Mary Smith. Now the IRS has opened it up a little bit to where you could do John Smith, LLC. Now, if the property is already held in an LLC, it has to be the same name of the LLC. You can't change it.

Reinvestment Requirement

Rule number seven, the reinvestment requirement. If you sell a building for $100,000 and have $20,000 in debt, then we have to buy a property that's worth at least $100,000 and $20,000 in debt. Through the magic of real estate leverage, you could take that $80,000 in equity and buy a $200,000 property, put $120,000 debt on the property. Now that's good leverage. What you don't invest is called boot. So if you only use $70,000 of that equity, that $10,000 is taxed with all the capital gains and the depreciation recaptured. It's just easier to reinvest all the proceeds.