1031
Basic 1031 Exchange Definitions
In addition to Best Practices, here are some basic definitions you should be familiar with when entering into a 1031 Exchange. Contact us for more details as there are several variations for particular exchange situations and proven "best practices" which will add value to your exchange process.
Like-kind: This term refers to the types of properties you can exchange. The type of replacement property must be the same, but the properties do not have to be the same quality. For example, you can exchange from property held for investment into other property held for investment. Property held for business use can be exchanged into other property held for business use. You could even exchange from apartments to single tenant net leased properties. or from land which was held for investment to income property held for investment. However, you cannot exchange a property that was held for investment for a property to be used for personal use or exchange investment property for land to develop and sell as lots. That is referred to as dealer activity and is normally taxed. The relinquished property is the property or properties you are selling. The replacement property is the property or properties you are acquiring.
Intermediary: An intermediary is a third party who acts as a middle man in the 3-way trade or exchange of properties and funds. The 1031 Exchange process must have the participation of an intermediary to temporarily holds the funds until you close on the replacement property. You cannot receive or hold the cash from the sale of the relinquished property. The costs are minimal, as low as $500 for a simple transaction. The firm holds the funds and provides the paperwork to properly facilitate the exchange. There are several safe intermediary firms around the country. If the intermediary handles your transaction improperly, or handles other transactions improperly, your transaction could possibly have some unpleasant tax consequences. For example, as an improper practice, your intermediary cannot also act as your broker.
Boot: The cash proceeds from the sale of the relinquished property is referred to as “boot”. It’s important to note, you can add additional cash into the acquisition of replacement property, which effectively gives you more options for a possible replacement property. To fully defer the transaction from taxes, the boot must be reinvested into replacement property. So, if your boot is $ 1 million, you must invest at least $1 million in the replacement property. If you want to use some of the boot for another purpose, for something fun like a boat, or for a business or stock investment, we have found some ways to accommodate those needs safely within the 1031 guidelines.
Simultaneous Exchange: In this situation, the entire trade is done at one closing.
Delayed Exchange: More commonly, you sell the relinquished property first and later close on replacement property. This allows you to properly market the relinquished property and allows you time to pick a replacement property. The general guidelines in a delayed exchange are to identify replacement property within 45 days from the closing of the relinquished property, and to close on the replacement property within 180 days from the closing of the relinquished property. You can identify up to three properties. You can close on one, two or all three so long as the other guidelines are met. The notification of the identified property is sent to your intermediary as per their guidelines and the 1031 tax code requirements. There are variations on the basic identification rules and general time frames.
Debt Leverage: While all of the net equity from the relinquished property must be reinvested in the replacement property, you do have some flexibility when it comes to replacing debt. The debt which is paid off when you sell the relinquished property may be replaced with new debt, new cash, or any combination of the two when purchasing your replacement property. This allows you to increase the debt leverage in your investment, should you prefer to infuse greater equity into replacement property.
Through helping thousands of 1031 investors over many years, we have seen what investors do right and what investors do wrong. To discuss best practices for your 1031 exchange, contact Bull Realty at https://bullrealty.com/contact-us-form.