Top 10 Misconceptions About 1031 Exchanges for 2020
For 2020, here are our latest top 10 misconceptions we’ve found that the public has about 1031 Exchanges.
- COVID-19 pandemic 1031 Extensions
- Replacing Debt
- The Term Like-Kind
- Vacation and Second Homes Qualify
- Reverse Exchange
- Partial Exchange
- Qualified Intermediary Advice
- Identification Rules
- Timing Deadlines
- Loans, Equity & Tax Basis
1. COVID-19 Pandemic 1031 Extensions
IRS issued extensions that were granted for the 45 day Identification and 180 day exchange period for the COVID-19 pandemic are still in place.
IRS extensions granted due to the COVID-19 pandemic ended July 15, 2020.
2. Replacing Debt
You must replace the debt that you had on the Relinquished Property with at least the same amount of debt on the Replacement Property.
Many taxpayers (and tax advisors) are under the misconception that the IRS mandates that they must have equal or greater debt on their 1031 Exchange Replacement Property (property they are purchasing). You do need to replace the VALUE of the debt paid off on the Relinquished Property. However, the debt does not have to be replaced with debt. The exchanger can always bring their own cash (from outside of the 1031 Exchange) to the closing table for the Replacement Property to offset any reduction in debt, or use other options.
3. The Term Like-Kind
“Like-kind” is restricted to the same kind of real estate which means I must exchange the same type of property, for example, an apartment building for another apartment building.
The term “like-kind” refers to the nature or character of the property, not its grade or quality. For this reason nearly all real property is like-kind to all real property, meaning that you can exchange an office building for an apartment complex, a strip mall, a warehouse, single family rental properties or even vacant land.
4. Vacation and Second Homes Qualify
Vacation or second homes qualify for 1031 Exchange tax deferral.
You can sell your investment real estate and reinvest the gain, tax deferred, to purchase your vacation or second home, however the challenge is making sure it will qualify as a 1031 investment property. Certain requirements must be met.
5. Reverse Exchange
In a Reverse Exchange, it’s as simple as buying new 1031 Replacement Property first, as long as my Relinquished Property is sold within 180 days.
In concept the Reverse Exchange is simple, but in execution, there are details and rules that must be followed. In a Reverse Exchange, you cannot own your Replacement and Relinquished Properties at the same time. Many do not realize that that title to their new Replacement Property must be “parked” with an EAT (Exchange Accommodations Titleholder) until their old Relinquished Property is sold. It takes considerable time to properly structure and execute a Reverse Exchange. Before you close on any property sale, reach out to IPX1031, your Qualified Intermediary, to ensure your 1031 Exchange is properly structured, timed and executed.
6. Partial Exchange
It’s not possible to do a partial 1031 Exchange.
A 1031 Exchange does not need to be an all or nothing scenario. You can do a partial 1031 Exchange which qualifies for tax deferral under Section 1031 of the Tax Code. If you purchase property lower in value or take a portion of the cash from the closing of the sale and only invest a portion of your proceeds towards a 1031 Exchange, you will have a partially tax deferred transaction rather than deferring all of your taxes. You will pay taxes on those funds not reinvested (commonly referred to as boot).
7. Qualified Intermediary Advice
A Qualified Intermediary gives tax and legal advice as part of their role.
While a Qualified Intermediary (QI) like IPX1031 is generally needed to create the “exchange of properties” and safeguard the exchange funds, QIs cannot provide tax or legal advice. IPX1031 cannot act as your advisor to structure your exchange transaction.
8. Identification Rules
I can change my identification after day 45 if that property has been sold to someone else and if needed, I can buy other 1031 Replacement properties that I didn’t identify.
The 1031 ID rules are strict and very important. We’ve seen many exchanges fail due to exchangers not following these 1031 Exchange identification rules. From the day your Relinquished Property closes, you have 45 calendar days to identify potential replacement property using the 3 Property Rule (most common), 200% Rule or 95% exception. You can change your identification at any time prior to the expiration of the identification period. If you did not identify a property in the proper time period, that property does not qualify for 1031 treatment. In the case of an identified property no longer for sale, if you have no other identified property and it’s after day 45, your exchange will fail. Remember to start your search for identification property early – even before your Relinquished Property closes – so you have a head start in the identification process.
9. Timing Deadlines
I have 45 days to identify then an additional 180 days to close.
The 45 and 180 day periods are not separate time periods. All must happen within a total of 180 calendar days. From the time your Relinquish Property closes, you have 45 calendar days to identify your Replacement Property. Then you must buy and close on any identified Replacement Property(ies) that you want to purchase in your exchange within a total of 180 calendar days. Timing rules are strict and cannot be extended even if the 45th day or 180th day falls on a Saturday, Sunday or legal holiday. They may, however, be extended by up to 120 days if the Exchanger qualifies for a disaster extension under Rev. Proc. 2018-58.
10. Loans, Equity & Basis
Loan balance or equity increases tax basis in a 1031 Exchange.
The term “basis” is the cost of a property for tax purposes. When you sell a property, the difference between the sales price and the adjusted basis in the property will determine the amount of capital gain which is taxable. Loans or equity are typically not relevant and do not factor into basis.
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