Article Category: 1031 Exchange

1031 Exchanges and Five Common Misconceptions

There remain deep-rooted misconceptions about Section 1031 of the Internal Revenue Code.

1031 Exchanges Common Misconceptions

A 1031 Exchange, also known as a tax-deferred exchange, is a common, fairly straight forward strategy that affords significant tax advantages to commercial property owners. Thanks to IRC § 1031, real estate investors may sell or relinquish certain qualified property, reinvest proceeds from that property and acquire a replacement property, pursuant to certain time limitations and other regulations. To put…

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1031 Exchange Rules

There are several general rules that apply to all 1031 exchanges:

1031 Exchange Rules

The 1031 like-kind tax deferred exchange originates from Section 1031 of the U.S. Internal Revenue Code. This section of the IRS Code allows real estate investors to defer the payment of capital gains tax that would normally be due when real estate is sold (or relinquished) by purchasing another like-kind replacement property. 1031 exchanges are also known as Starker Exchanges,…

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Qualified Intermediaries and Their Role

A Qualified Intermediary is an independent third party who acts on behalf of the exchanger.

A bridge figuratively represents qualified intermediaries

The IRS requires that money generated from the sale of the relinquished property must be held by a qualified intermediary until the replacement property is purchased.  If the investor touches or in any way controls funds used for a 1031 exchange, the exchange will be disallowed by the IRS and tax on the capital gains must be paid. A Qualified…

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Reverse 1031 Exchange Explained

Reverse 1031 exchanges can be quite complex. We will explain the process.

The Reverse 1031 Exchange Explained

Reverse 1031 Exchange – Here is How it Works By following the rules and guidelines in Section 1031 of the Internal Revenue Code, real estate investors and business owners can defer paying capital gains tax by selling real estate property and replacing it with another like-kind property. 1031 tax deferred exchanges generally fall into three categories: delayed, reverse, and build-to-suit….

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Frequently Asked Questions

  • Are there limitations when a DST-Structured property is used as a 1031 Exchange?

    The IRS has determined that for a Delaware Statutory Trust (DST) to qualify as a replacement property in a 1031 exchange, each investor must be absolutely passive in the on-going investment operations.

    • Investors with interests in a DST structured property relinquishes control over the property operations and control over the sale of the property.
    • There is no secondary market for DST interests and considerable restrictions may apply to the transfer of DST interests.

  • What are the advantages of a DST-Structured investment in commercial property?

    There are numerous advantages to investing in a DST structured property offering.

    • The purchase of DST interests is simpler, faster and does not require as many documents as buying sole ownership of a property.
    • Capital Gains are deferred, if investment is for a 1031 Exchange
    • No daily property management obligations that come with sole ownership
    • Ability to create a diversified real estate investment portfolio
    • Cash flow distributions
    • Annual depreciation/tax deductions
    • Appreciation upon sale of the property
    • Upon the sale of a DST property, the investor may engage in a 1031 exchange, even if the DST interest was purchased without 1031 exchange proceeds.
    • A DST is a pass-through tax entity, which is not subject to federal income tax, nor to the Delaware franchise or income tax.
    • Because the DST is the mortgage borrower, the lender does not require individual DST investor guarantees, nor does the lender require investors to submit personal financial information to qualify for the mortgage loan.
    • Investors with interest in a DST property are protected from property liabilities held by the DST. As a result, the maximum pre-tax loss (excluding income tax considerations) is equal to the amount invested in the DST.

  • How does an investment in a DST-Structured property differ from an investment in a tenants-in-common structured property?

    Like TICs, DST’s have multiple investors that purchase fractional interests and the investors share in the total financial performance of the underlying investment property. However, the primary differences between the two investment structures are:

    • A DST is not limited to a maximum of 35 investors required by Revenue Procedure 2002-22.
    • DST investors are purchasing a fractional interest and do not receive deeded property
    • Investors do not form single-member Limited Liability Companies (LLCs). Investors are already insulated from liability as a result of the trust structure of the property.
    • Investors do not have voting rights or operational control of the property
    • In a DST structure, there can be no cash calls or additional money invested into the property beyond typical maintenance and capital expenditure needs.

  • Are there a minimum and maximum investment amounts to participate in a DST property offering?

    Yes; $50,000 to $100,000 are typical minimum and maximum investment amounts but this may vary from sponsor to sponsor.

    The maximum amount is contingent on the overall size of the property investment and discretion of the investment sponsor

  • Are DST-Structured properties commonly used for a 1031 Exchange?

    Since approved by the IRS in 2004, Interests in Delaware Statutory Trusts has since become the primary investment method for pooled 1031 exchange investments.

  • How is a replacement property identified?

    A like-kind replacement property is identified if it is either

    • Identified in a written agreement using a portion of the impounded funds for the earnest money deposit
    • Designated as replacement property in a written document signed by the exchanging party and received by the QI before the end of the 45-day identification period

    The property ultimately acquired must be substantially the same as that identified.

  • What Qualifies as a “like-kind” Replacement Property?

    The definition of a qualifying like-kind property is very broad, for both the sold property and the replacement property: real estate used for investment or business purposes. Personal use property is not eligible.

    Investment real estate (held for either appreciation or for rental) can be exchanged for real property used in a trade or business. Partial interests such as tenants-in-common or Delaware Statutory Trusts, are exchangeable with other types of real property (including a land contract in which equitable title has been transferred).

  • What is a 1031 Exchange?

    Subject to rules and conditions set by IRC 1031, a 1031 Exchange allows an investor to sell a property and then to reinvest the proceeds in a new property and to defer all capital gain taxes.

  • How a 1031 Exchange is Accomplished?

    There are eight steps common to any Section 1031 tax deferred exchange:

    • Step 1: Retain the services of a certified public accountant or an attorney with tax deferred exchange experience
    • Step 2: Enter into a 1031 exchange agreement with a qualified intermediary, being sure to name the qualified intermediary as the principal in the sale of the relinquished property and in the purchase of the replacement property
    • Step 3: Sell the relinquished property, making sure to include a cooperation clause requiring the buyer to cooperate with the seller’s 1031 exchange, and instruct the escrow officer or closing agent to order exchange documents from the qualified intermediary
    • Step 4: Escrow closes on the relinquished property, with the closing statement showing the qualified intermediary as the seller, and sales proceeds from the relinquished property are sent to the intermediary and placed in a separate segregated trust account
    • Step 5: Within 45 days of the close of escrow of the relinquished property the taxpayer identifies one or more replacement properties and sends written notice of this to the qualified intermediary
    • Step 6: The taxpayer executes a purchase contract with the seller of the replacement property, making sure the cooperation clause is included in the purchase contract, and naming the qualified intermediary as the buyer of the replacement property
    • Step 7: Within 180 days of the close of escrow of the relinquished property, the taxpayer instructs the qualified intermediary to transfer funds to close and send 1031 exchange-related documents to the escrow company, and the sale closes with the closing statement showing the qualified intermediary as the buyer
    • Step 8: The taxpayer reports the 1031 exchange to the IRS when filing his normal tax returns

    After the replacement property has closed escrow the qualified intermediary will send a final accounting statement to the taxpayer. The statement will show that funds have come from one escrow directly into another, all without the taxpayer having constructive receipt of the funds.

    Real estate investors should note that although the qualified intermediary is indicated as the seller and buyer on the purchase contracts, the deed and title are always from the taxpayer to the buyer, and from the seller to the taxpayer.

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