Structuring Your 1031 Exchange Transaction
Sometimes it’s obvious which type of 1031 exchange to use. More often, property transactions are complex and it’s not immediately obvious how or even if a transaction can qualify for a 1031 exchange. Use the information here as a guideline. Talk with your 1031 exchange facilitator about the best way to structure your transaction to meet your needs.
SIMULTANEOUS EXCHANGE – Initial property is sold and replacement property is purchased at the exact same time and at the same escrow office. This is the original type of 1031 exchange. The simultaneous exchange can be logistically difficult to accomplish, especially with a complex transaction involving properties in different cities or states. Due to the nature of the transaction only one party in the transaction can do a 1031 exchange.
DELAYED EXCHANGE – Property is sold and replacement property is purchased within 180 days. Replacement property must be identified within 45 days. Because of the 180 day window this is the most popular type of 1031 exchange.
IMPROVEMENT EXCHANGE – Also known as a “construction” or “build-to-suit” exchange. In order to have a completely tax deferred transaction, the exchanger must trade “across” or “up” in equity and debt. If the exchanger goes down in value when acquiring the replacement property he/she will have a tax liability on the cash or mortgage boot.
By making improvements to the property the exchanger can defer the tax liability. Note these important requirements.
- The replacement property is built-to-suit, improved or altered to the specifications of the exchanger.
- The construction is done in accordance with the building specifications outlined in the purchase contract, and/or escrow instructions.
- The exchanger approves all work done before disbursement of funds by the exchange facilitator and exchangers may use the contractor of their choice as long as they are not a disqualified person under the regulations.
- While real property improvements need not be completed within the exchange period, the value of any portion of the improvements not completed within this time frame will not qualify as replacement property.
- The 180 day exchange period may effectively be extended by delaying the transfer of the relinquished property. This may allow some time for work to begin on construction of improvements to the replacement property.
- Property “to be produced” in a construction exchange, which is not completed within the 180 day exchange period, must be part of the standing structure to be considered real property under local law. A load of raw building material delivered to the building site, will not qualify as improved real property.
- Only certain exchange intermediary companies specialize in improvement exchanges. Please reach out for more information.
REVERSE EXCHANGE – The replacement property is purchased before the initial property is sold. This is an option when the exchanger must close on the replacement property before a buyer has been found for the relinquished property.
Special care must be taken with reverse exchanges.
- 1031 exchange regulations do not allow the exchanger to own the new and old property at the same time.
- In some states complications can come up related to deed transfer taxes.
- Accounting for all the equity from the old property into the new property.
- Due on sale clauses that may exist with the current mortgage holder.
Though improvement and reverse exchanges are more involved and complicated than other types of exchanges, sometimes they are the only solution to an otherwise impossible exchange transaction. These greatly expand the ability of the investor to maximize his/her investment position.
When You Cannot Use a 1031 Exchange
A few situations do not qualify for a 1031 exchange, such as:
- Residential property you live in or intend to live in. (Profits on a primary residence have special treatment under code 121.
- Property you intend to resell.
Talk with us today to determine whether your transaction qualifies and how a 1031 exchange can be structured for you.