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A 1031 exchange, or like-kind exchange (LKE), allows you to defer various forms of taxes—including capital gains, depreciation recapture, and state tax in most states. You can be eligible for a 1031 Exchange when you sell real estate that meets these requirements.
Like-Kind Requirement
Generally, all real estate is like-kind to other types or kinds of real estate. For example, an apartment building could be exchanged for a retail center.
Use of a Qualified Intermediary
An unrelated third party or Qualified Intermediary (QI) may be used to facilitate the 1031 exchange transaction. A taxpayer cannot utilize their realtor, lawyer, accountant or a related party, or agent as a QI. Additionally, several states require that QIs be compliant with regulatory requirements regarding insurance, bonding, and the manner in which exchange funds are held, state licensing, etc.
Time Limits & Identification Requirement
A taxpayer is required to acquire or identify the target replacement property within 45 days after the transfer of the relinquished property. A written document that recognizably identifies the replacement property must be signed by the taxpayer and received by the Qualified Intermediary on or before the 45th day. Properties acquired within the 45-day designation period are deemed to be identified.
A taxpayer has 180 days (or the due date for filing of taxes for the year the property was sold) to acquire the replacement property. For example, if the relinquished property is sold in December, the due date for filing the tax return for that year would be less than 180 days. In such case, it would be necessary for the taxpayer to file for a tax-filing extension in order to utilize the full 180 days.
You have 45 days after the sale of your relinquished property to identify your replacement property(ies). Identification of replacement properties must be unambiguous, using a legal description or physical address. It must be in writing, dated, signed, and received by your QI within the 45 days. The 45-day requirement is strictly enforced with no option for extension.
You have 180 days after the sale of your relinquished property to purchase your replacement property(ies). The 180-day requirement is strictly enforced with no option for extension. Additionally, your replacement period could be shorter if your tax return due date is prior to the expiration of the 180 days, if that is the case you will want to file an extension on your tax filing.
The IRS provides three rules in which you can identify your replacement property(ies). The most common being the 3-property rule, simply put you can identify three properties. The 200% rule allows you to identify more than three properties so long as the fair market value of all properties does not exceed 200% of the sales price of your relinquished property. Lastly, the 95% rule states that should you over identify the first two rules then you have to purchase 95% in value of what was identified.
For a 1031 exchange to be valid, your properties must be like-kind. As it pertains to real estate, all real estate is like-kind to other real estate. Some examples would include: an apartment complex exchanged for a cell tower easement; an office building for farmland; or a rental home for water rights. Generally speaking, the only real estate that does not qualify under a 1031 exchange is a vacation home and personal primary residency.
You have the option to purchase one or all of the properties you identified; you are not required to purchase all identified properties. Identifying more than one property just provides you with more options to ensure you have a replacement property within the 180-day exchange period. Additionally, you need to state how many properties you plan to purchase.
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