Considerations for a Successful 1031 Exchange

Considerations for a Successful 1031 Exchange

Considerations for a Successful 1031 Exchange

By: Juno Kenny

As with all complicated processes, even the most well-intentioned investor can run into issues without the proper planning and advice. For this reason, it is crucial that exchangers are aware of any potential issues they may run into before taking part in an exchange. In this article we will cover some considerations that will help to ensure a successful 1031 exchange.

    1. Do not take constructive receipt of any exchange funds.

    One of the requirements of a 1031 exchange is that the exchanger must not take constructive receipt of the exchange funds. If constructive receipt occurs, it will trigger a taxable event and, in some cases, it can disqualify your entire exchange. In practice, this means that any funds that flow into the exchange account must remain there for the duration of the exchange.

    It should be noted that any amount of the sale proceeds can be withheld at closing if you would not like to include them in the exchange. This is what is referred to as a partial exchange. Something else to consider, disbursements from the exchange account made on behalf of the exchanger can be construed as constructive receipt if the subject of the payment is not considered an exchange-permissible expense (e.g., purchasing equipment for a property, paying loan fees, purchasing furniture). Because of this, it is always important to seek your tax advisor’s approval before requesting or approving disbursements from the exchange account.

    For more information on how and when cash can be taken out of an exchange, please visit “Taking Cash Out of a 1031 Exchange”

    1. Make sure that the Tax Identification Number (“TIN”) of the exchanger is maintained throughout the exchange.

    As the IRS tracks deferred gain throughout time, it is linked to the Tax Identification Number (“TIN”) of the Exchanger in question. What this means for the exchanger is that the TIN of the entity on title for the relinquished property must be the same as the TIN of the entity purchasing the replacement property. This is commonly referred to as the “same taxpayer rule”. For exchangers who own properties using multiple different entities, this is especially important to consider, particularly if there are multiple transactions occurring at the same time.

    For more information on the “Same Taxpayer Rule”, please visit “Same Taxpayer Requirements in a 1031 Exchange”

    1. Purchase property of equal or greater value than what was sold for full capital gains tax deferral.

    For full capital gains tax deferral, the exchanger must purchase a property that is of equal or greater value than the property that was sold. We can refer to this value as the Replacement Property Target Value (“RPTV”). RPTV is determined using the following equation:

    Rel. Prop. Sale Price – Rel. Prop. Permissible Closing Costs – Rep. Prop. Permissible Closing Costs = RPTV

    If the aggregate value of the replacement property/properties are lower than the RPTV, this will result in the difference being subject to any applicable taxes, this is also what is known as a partial exchange.

    Equity also needs to be maintained throughout the exchange and should not be replaced with debt. If equity is replaced with debt, even if the exchanger purchases a property that is of higher value than the RPTV it will create a taxable event. However, debt can be replaced with equity.

    For more information on debt replacement in a 1031 exchange please visit “The Debt Replacement Requirement in a 1031 Exchange”

    1. Make sure that replacement properties are identified correctly.

    Once the relinquished property sale closes, the exchanger has 45-days to identify any potential replacement properties. There are three rules of identification, and the exchanger must utilize one of the following options in order to meet the exchange requirements:

    1. The Three-property rule: Under the three-property rule, the exchanger can identify up to three properties without regard to their fair market value.
    2. The 200% rule: Under the 200% rule, the exchanger can identify any number of properties as long as their aggregate fair market value does not exceed 200% of the fair market value of the relinquished property.
    3. The 95% exception: If the above three-property and 200% rules are not met, the exchanger can still satisfy the identification requirements provided that the exchanger acquires at least 95% of the fair market value of the properties identified.

    For more information on the identification of replacement property, please visit “Identifying Replacement Property Basics & Frequently Asked Questions”

    Strategic planning with your tax advisor and our team of experts at Genesis Bank Exchange can help maximize the potential of your investments. If you’re interested in learning more about the 1031 exchange process and how it may benefit you, connect with the Genesis Bank Exchange team by calling 800.797.1031, or explore further details on our website: https://www.mygenesisbank.com/1031Exchange.

The materials and content provided on this website are for general informational purposes only. These materials and content do not, and are not intended to, constitute legal, tax, or financial advice.

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