WHAT IS A 1031 EXCHANGE?Section 1031 of the Internal Revenue Code provides a strategy for deferring the capital gains tax that may arise from the sale of business/investment property. By exchanging the property for other "like-kind" property, investors and business owners may defer their capital gains tax and use all of the sale proceeds to purchase replacement property.
What is "Investment" and "Like-Kind" Property?Investment Property: any property that is "held for productive use in a trade or business or for investment." This includes real property and personal property (e.g., business use assets, such as company cars and construction equipment). This does not include stock in trade/store inventory, property held primarily for resale (e.g., house flips), interests in partnerships (see IRC Section 761(a) on how to elect out of partnership status in preparation for a 1031 exchange), and primary residences.
Like-Kind Investment Property: refers to the nature or character of the property, ignoring differences in quality or grade. For example, vacant land is like-kind to developed land, because the lack of improvements is a distinction of quality or grade, and both assets are real estate based. Treas. Reg. Section 1.1031(a)-1(b). For personal property exchanges, however, this like-kind rule is more narrowly construed.
Selling "Relinquished Property" and the Role of "Qualified Intermediary."Relinquished Property: the first business/investment property that is sold to a third-party buyer, and the sale of which begins your 1031 exchange.
Replacement Property: the next business/investment property that is purchased with the 1031 exchange funds from the sale of Relinquished Property.
Qualified Intermediary: the Exchanger cannot receive or control the the proceeds from the sale of the Relinquished Property, these proceeds must be deposited with a third-party Qualified Intermediary. 1031trx is a professional Qualified Intermediary, owned and operated by a licensed New York State attorney. 1031trx holds "exchange funds" in an insured attorney escrow account (instead of re-investing them for short-term gain, like other Qualified Intermediaries will do), and structures the 1031 exchange processes with all other parties.
45-Day Identification Period and 180-Day Exchange Period.45-Day Identification Period: once the Relinquished Property is sold, the Exchanger has 45 days to identify Replacement Property options. Multiple Replacement Properties can be identified, most commonly the "3 property rule" is used (whereby the Exchanger identifies up to 3 like-kind properties without regard to their fair market value).
180-Day Exchange Period: the Exchanger must receive the Replacement Property within the earlier of (1) 180 days after the Relinquished Property was sold, or (2) the Exchanger's tax return due date (including extensions) for the tax year during which the Relinquished Property was sold.
These time periods are very strict and cannot be extended, regardless of whether the 45th day or the 180th day falls on a weekend or legal holiday. In rare instances, IRS extends these time periods for extreme disasters (e.g., September 11th and severe hurricanes).
What is "Boot" and Does it Matter if There is Financing Involved?Boot: generally, the cash used to purchase Replacement Property should be equal to or greater than the cash received from the sale of the Relinquished Property. Leftover exchange funds are called "boot" and this is taxable gain The receipt of boot does not disqualify the 1031 exchange.
Some examples of boot are: cash, debt relief that is not offset with new debt, and any property the Exchanger receives that isn't like-kind to the Relinquished Property.
Financing: generally, the debt placed on Replacement Property should be equal to or greater than the debt relieved with regard to the Relinquished Property. Otherwise, the Exchanger is relieved of a debt obligation, which is taxable "mortgage boot," unless it is offset by adding equivalent cash to the purchase price of the Replacement Property.