1031 Tax Exchange DOs and DON`Ts
Published on Sept. 22, 2010
Do: Utilize a Qualified Intermediary to handle your exchange proceeds.
If you take possession (constructive receipt) of the proceeds from the sale of your property, this will forfeit your ability to complete a 1031 exchange. A Qualified Intermediary is a company set up to handle the transfer and close of 1031 exchange funds so that investors do not take constructive receipt.
Do: Contract with a Qualified Intermediary that is both experienced and bonded.
The QI must be able to handle your transactions in compliance with IRS guidelines and should have fidelity bonding to protect you from fraud. We can refer you to at least three QIs that meet these guidelines.
Do: Identify your replacement properties in the IRS appointed time.
The IRS provides 45 days from the close of escrow to identify replacement properties.
Do: Use the IRS Identification Guidelines to your advantage.
The IRS provides three different identification rules to meet your replacement needs. Most people use the 3-Property Rule, but it is important to note that you can utilize the other rules in order to diversify your replacement property choices.
Do: Reinvest all exchange proceeds that you do not want exposed to tax.
You pay tax on proceeds not reinvested.
Do: Purchase a property with equal or greater value.
If you acquire real property that is of lesser value than the property you sold, you will have to pay tax on the difference.
Do: Purchase your replacement property in the U.S. or U.S. Virgin Islands.
Foreign investment property does not qualify.
Don't: File your income taxes for the year in which you do your real estate exchange until you complete your exchange.
Do this and lose the benefits of the 1031 exchange!
Don't: Reinvest the proceeds in property you already own.
Do this and lose the benefits of the 1031 exchange!
Don't: Wait until the last minute.
Time is important! You have 180 days from the escrow close to complete your purchase of a replacement property. Exceed this time limit and lose the benefits of the exchange!
Don't: Dissolve partnerships or change the manner of holding title during the exchange (without consulting an expert on exchange entities).
Do this and lose the benefits of the exchange!
Don't: Forget that you may not need to complete a 1031 real estate exchange.
You may not need to complete a 1031 real estate exchange if you do not have any material capital gains tax exposure. Make sure to consult the capital gains worksheet to calculate the taxes on your investment property sale. We also can refer you or your tax counsel to a CPA specializing in 1031 and Triple Net (NNN) real estate to review your tax situation.
Don't: Overlook your other tax-advantaged options.
Though a 1031 exchange is often one of the best options for someone selling investment property, there are other options available that can provide further flexibility and diversification. For example, the Deferred Sales Trust and the 721 exchange allow investors to defer their capital gains after a sale but diversify their funds far more than the typical 1031 real estate exchange. For a list of these and other options with analysis, please contact us.