26 U.S.C. § 1031(a)(1) reads:  “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

Generally, when real property is sold the taxpayer is required to pay taxes on the gain at the time of sale.  However, Internal Revenue Code (the “Code”) Section 1031 allows for the opportunity to defer paying taxes on the gain if a taxpayer reinvests in a replacement property pursuant to the Code and guidelines provided by the Internal Revenue Service (the “Service”).  This article endeavors to explain the general requirements of a 1031 exchange involving real property.

Property Available for a 1031 Exchange

There are primarily two requirements concerning both the relinquished property and the replacement property involved in a 1031 exchange:  (1) each property must be “held for productive use in a trade or business or for investment;” and (2) the property must qualify as “like kind.”

The Holding Requirement:

Both the relinquished property and the replacement property must meet this “holding” requirement.  The taxpayer’s intent at the time of the exchange determines whether this requirement is satisfied.  Although the actual time the property held is highly suggestive of the taxpayer’s intent, the Service is cognizant that circumstances change and that intentions may adjust accordingly.  A conservative recommendation is that the relinquished property be held for 2 years preceding and the replacement property be held for 2 years subsequent to the 1031 exchange “for productive use in a trade or business or for investment.”

Real property used as a personal residence does not meet this requirement.  Similarly, vacation homes generally are disqualified; provided, however, vacation homes in which the taxpayer rents out the home for the majority of the time preceding/post 1031 exchange, as applicable, may qualify.

Expected appreciation in the value of real property is not enough to qualify as “holding for investment.”

The Like Kind Requirement:

Generally, all interests in real property can qualify for an exchange and thereby be considered “like kind,” including:

  • improved and unimproved land;
  • perpetual easements;
  • leases having 30 or more years remaining in the term of the lease;
  • tenancy in common interests;
  • development rights; and
  • membership interests in a single-member limited liability company to the extent that the company’s property at the time of the exchange consists of qualifying “like kind” property.

Real property cannot be exchanged for personal property (and vice versa) as the replacement property and the relinquished property can never be “like kind.”  Also, additional issues may arise surrounding the “like kind” requirement when personal property is included as part of the real property being exchanged (i.e., apartment complexes with refrigerators, washing machines, etc.).

Different Types of 1031 Exchanges

There are generally three different types of 1031 exchanges, based upon the timing of the exchange:  (1) the simultaneous 1031 exchange (i.e., exchanging the relinquished property for the replacement property directly and/or on the same closing date); (2) the delayed 1031 exchange (i.e., the immediate disposition of the relinquished property and the later acquisition of the replacement property); and (3) the reverse 1031 exchange (i.e., the immediate acquisition of the replacement property and the later disposition of the relinquished property).

  1. Simultaneous Exchange:

While a simultaneous exchange is ideal in that it avoids many issues and requirements associated with the other types of 1031 exchanges, it is rare to find a party willing to exchange properties and/or coordinate multiple transactions resulting in an exchange of properties to close on the same date.  Issues almost always arise which push the closing for one of the transactions involved which puts the entire 1031 exchange in jeopardy.  The alternative scenarios allow the taxpayer greater flexibility to structure the best transaction for the taxpayer’s needs and the ability to adjust as issues arise.

  1. Delayed 1031 Exchange:

 A delayed 1031 exchange is the most common exchange structure.  It must be distinguished from an initial disposition and a subsequent acquisition of otherwise qualified property.  The delayed 1031 exchange is accomplished by making the disposition and acquisition parts of an integrated transaction subject to an exchange agreement entered into with an exchange facilitator (a “Qualified Intermediary”) who creates a recognized buffer between the taxpayer and any non-qualifying property (i.e., the proceeds from the disposition).  The taxpayer enters into the Purchase and Sale Agreements for both the relinquished and the replacement properties.  The taxpayer assigns the Purchase and Sale Agreements to the Qualified Intermediary prior to the closing of the transactions such that the Qualified Intermediary is recognized as the party to the underlying transactions.  While the Qualified Intermediary is the party to the underlying transactions, the taxpayer will directly deed the relinquished property to the buyer and directly receive the deed for the replacement property from the seller, so as to allow the Qualified Intermediary to avoid being part of the chain of title for the properties (and thereby also avoiding the taxes and fees associated with the multiple deeds that would otherwise be required).  The Qualified Intermediary holds the proceeds from the initial disposition of the relinquished property and uses the proceeds to fund the subsequent acquisition of the replacement property.

Critical Dates for Delayed 1031 Exchanges

Closing – Title to relinquished property is transferred to the buyer, and the sale proceeds are directly deposited from escrow with the Qualified Intermediary.

 On or before Day 45 after Closing – Replacement property is identified in writing to Qualified Intermediary.  While one replacement property can be identified, multiple properties can be identified per the following rules:  (a) The Three-Property Rule: identify any 3 potential replacement properties; (b)  The 200% Rule: identify any number of potential replacement properties so long as their aggregate fair market value (“FMV”) does not exceed 200% of the FMV of the relinquished property; or (c) The 95% Rule: identify any number of replacement properties so long as the FMV of the actual replacement properties are 95% of the aggregate FMV of the identified potential replacement properties.

 On or before Day 180 after Closing – Title to replacement property is transferred to the taxpayer.  The Code provides that title to the replacement property be transferred “the earlier of  (i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (ii) the due date (determined with regard to extension) for the transferor’s return of the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs.”  Extra attention needs to be paid when beginning a 1031 exchange at year’s end to account for the filing date for the taxpayer’s taxes (which may shorten the maximum 180 day period).

The foregoing timeframes are absolute and may not be extended, so care must be taken to make sure deliverables happen within the required timeframes.

  1. Reverse 1031 Exchange

 The Service has created a “safe harbor” in which a reverse 1031 exchange will not be challenged.  This safe harbor consists of entering a “Qualified Exchange Accommodation Agreement” with an exchange accommodation titleholder  (an “EAT”) who will temporarily take title to the replacement property while the disposition of the relinquished property is pending.  The taxpayer loans the EAT the money to purchase the replacement property.  Once the relinquished property is sold, title to the replacement property, along with the proceeds from the sale (by and through a Qualified Intermediary), is transferred to the taxpayer. 

Critical Dates for a Reverse 1031 Exchange

 Closing – Title to replacement property is transferred to the EAT.

On or before Day 5 after Closing – Qualified Exchange Accommodation Agreement entered.

On or before Day 45 after Closing – Relinquished property is identified in writing to Qualified Intermediary. Potential identification of multiple potential properties subject to same identification rules discussed above for delayed 1031 exchanges.

On or before Day 180 after Closing – Title to relinquished property is transferred to buyer and Title to replacement property is transferred to the taxpayer.  Same caveat discussed above for delayed 1031 exchanges regarding exchanges begun near the end of a calendar year.

 Related Party Transactions

 Additional rules are applicable if a “related party” is involved in the exchange, that is to say, if the relinquished property is being transferred to a related party or the replacement property is being transferred from a related property, or both.  “Related parties” include, but are not limited to, brothers, sisters, spouses, ancestors and lineal descendants, as well as a corporation and a shareholder holding more than 50% of the shares in two affiliated corporations.  In certain instances, exchanges are disallowed; and, when allowed, the requirements must be strictly adhered to or the exchange subsequently fails.

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This article provides a brief overview of the logistics of a 1031 exchange.  While conceptually quite simple, the Code and the guidelines promulgated by the Service tend to be more complex than a general article can adequately cover.  Legal counsel should be consulted any time a taxpayer is considering a disposition with the potential for reinvesting the proceeds in another property.


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The foregoing article was prepared by Richard Rasmussen and Pablo De Leon of Anglin Flewelling Rasmussen Campbell & Trytten LLP (AFRCT).  AFRCT is a full-service business law firm providing legal counsel in most every area encountered by businesses in California, Oregon and Washington.