The term 1031 Exchange is defined under section 1031 of the IRS Code. To put it simply, this strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long another “like-kind property” is purchased with the profit gained by the sale of the first property.

1. 1031 Exchanges - By the Rules
Presented By
Lee Offir, Esq., BCS,
Florida State Counsel
1

2. Introduction
Section 1031
Exchanges are
ALL about
avoiding
taxes……….
2

3. Section 1031
Exchanges are
ALL about
avoiding
taxes……….
…..OR, at least
deferring them!
3

4. Introduction – Why Do You Care?
 There are special contract provisions
required in any contract involving a
1031 Exchange.
 Understanding the exchange process is
going to help you understand what your
customer is looking for as an exchange
property.
 You’re going to know what to look
for better than they will.
 As a method to defer taxes, these have
fallen out of favor due to low long term
capital gains taxes.
 That’s likely to change with the new
administration, so you could see
more.
4

5. Introduction – History
STARKER EXCHANGES
 When Congress wrote Section 1031 in 1917, it was entitled "Exchanges."
Partly because of the title, taxpayers believed that to do an exchange, you
had to swap the deed for your purple duplex with the deed of a purple
duplex held by a similarly-minded taxpayer.
 In the mid-70s, T.J. Starker challenged that view by selling some timber
property, and instead of simultaneously swapping with another timber
property owner, Starker took cash from the closing and then bought
replacement timberland.
 The IRS sued Starker for not paying capital gains tax on the cash Starker
took from the sale. This case went all the way to the Supreme Court, and
surprisingly, Starker won.
 Taxpayers throughout the rest of the country immediately began doing
"Exchanges" (i.e., selling their property, taking cash proceeds, and then
buying the new property). The IRS argued that only Starker could do a
Starker Exchange. At the same time, the Supreme Court let it be known that
they would rule in the taxpayers' favor if any more Starker cases came their
way.
 Congress rewrote Section 1031 in 1991 and allowed taxpayers to buy any
other type of investment property, and imposed the qualified intermediary
requirement.
5

6. Introduction – the Law
§ 1031. Exchange of property held
for productive use or investment.
(a) Non-recognition of gain or loss
from exchanges solely in kind.
(1) In general, 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.
6

7. Introduction – the Law
(2) Exception
This subsection shall not apply to
any exchange of –
(A) Stock in trade or other
property held primarily for sale.
(B) Stocks, bonds, or notes.
(C) Other securities or evidences
of indebtedness or interest.
(D) Interests in a partnership.
(E) Certificates of trust or
beneficial interests.
7

8. Introduction – the Law
(3) Requirement that property be identified and that
exchange be completed not more than 180 days
after transfer of exchanged property
For purposes of this subsection, any property
received by the taxpayer shall be treated as property
which is not like-kind property if:
(A) Such property is not identified as property to be
received in the exchange on or before the day which
is 45 days after the date on which the taxpayer
transfers the property relinquished in the exchange.
(B) Such property is received after the earlier of
either:
(i) The day which is 180 days after the date on
which the taxpayer transfers the property
relinquished in the exchange.
(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. 8

9. Introduction – the Basics
 Sell property
 Sale proceeds go to
exchange agent.
 Cash is NOT received
by sellers.
 Identify new property
within 45 days.
 Close new purchase
within 180 days.
 No taxable gain
 Tax basis in the old
property is carried
forward into the new
property.
9

10. Introduction – Misconceptions
 Exchanges = simultaneous property
trade between two individuals.
 Residential property does not qualify.
 Exchanged properties must be of
equal value.
 Exchanges always involve two
properties.
 Exchanges must involve the same
category of real property (e.g., land
for land, etc.).
 Only the gain must be reinvested. 10

11. RULE NUMBER 1
Both the old and the new properties must be held for
investment or used in a trade or business.
 Property held for resale or being
flipped does not qualify for a 1031
Exchange.
 Intent is a major factor.
 Consensus is that property must be
held for a year and a day before it
can be exchanged.
 The primary reason is that it
prevents taxpayers from converting
short term gains into long term
capital gains.
11

12. RULE NUMBER 1
Both the old and the new property must be held for
investment or used in a trade or business.
 Cannot sell the property to a
“related party” and not realize
the tax value.
 “Related parties” includes
parents, grandparents,
spouses, brothers, and
sisters.
 First degree of
sanguinity.
 Doesn’t include Aunt Bea
or Cousin Matt.
12

13. RULE NUMBER 2
45-Day Identification Requirement
 From the date of closing the sale of
the old property, the taxpayers have
45 days to complete a list of the
properties they want to buy or
exchange into (includes weekends
and holidays).
 Taxpayers can list up to three
properties without value
limitations.
 If seller lists more than three
properties, the combined
purchase price cannot exceed
the aggregate of 200 percent of
the sales price. (the “200% Rule”)
 If they exceed this, exchange
disallowed.
13

14. RULE NUMBER 2
 List must be delivered to the
“qualified intermediary” (whom
we often call the “exchange
agent”) by the deadline, even if
it’s a holiday.
 The list must be prepared in a
way that an IRS agent could take
it directly to the door of the
property.
 Recommend you list it by
both address and legal
description.
 In other words, list must be
specific and in writing.
45-Day Identification Requirement
14

15. RULE NUMBER 2
 As a listing agent, you may
find yourself looking for a
property or group of
properties involving a
specific value, either
individually or in the
aggregate.
 You’ll be shopping, not just
showing.
45-Day Identification Requirement
15

16. RULE NUMBER 2
 Your target does not have to be
the exact same kind of real
property, provided it is real
property that can be used for
investment or income-producing
purposes.
 Your target MUST be within the
United States or the U.S. Virgin
Islands.
 Exception – when your property
sold is overseas property, the
property bought must also be
overseas property.
45-Day Identification Requirement
16

17. RULE NUMBER 3
 Again, from the date of
closing the sale of the old
property, you have 180 days
to close the purchase of the
new property.
 Time periods run
concurrently, so once your
45-day period runs, you
have 135 days to close the
purchase.
 IRS allows no extensions.
180-Day Purchase Requirement
17

18. RULE NUMBER 4
 Taxpayers cannot touch the
money between the sale of the
1st property and purchase of the
2nd.
 By law, taxpayers must use an
independent 3rd party to handle
the money.
 This is the “qualified
intermediary” or “exchange
agent.”
Qualified Intermediary Requirement
18

19. RULE NUMBER 4
 The qualified intermediary:
 Prepares the exchange
documents.
 Holds the proceeds from the
sale until the purchase of the
new property.
 The IRS has disallowed the
exchange, and therefore the tax
deferral, where the documents
have been created incorrectly.
Qualified Intermediary Requirement
19

20. RULE NUMBER 4
 IRS rules do NOT define who can be a
qualified intermediary.
 The IRS does list who CANNOT be:
 Taxpayer’s CPA
 Taxpayer’s attorney
 Taxpayer’s real estate professional
(YOU!)
 Relatives
 Employees
 Business associates
 The IRS is looking for a completely
independent party.
Qualified Intermediary Requirement
20

21. RULE NUMBER 4
 None of the 50 states or the federal
government defines or licenses who
can be a “qualified intermediary.”
 You might want to be careful who you
refer your client to.
 Taxpayers should ask about:
 Financial resources.
 Bonding.
 What they’re going to do with the
money.
 The bank being used.
 FDIC insurance.
Qualified Intermediary Requirement
21

22. RULE NUMBER 5
 The taxpayer who owns the
prior property must also buy
the new property.
 Cannot change business
entities, merge, or dissolve.
 With a partnership or LLC
breaking up, you should
break it up prior to the
exchange to make business
owners the direct owners of
the property.
 With some corporations, that
can create tax issues.
Title Requirements
22

23. RULE NUMBER 6
 In 1031 Exchanges, “boot” is the
IRS term for money in the
transaction which becomes taxable
to the taxpayer.
 The goal is usually to avoid boot.
Boot Issues
23

24. RULE NUMBER 6
 In order to defer all tax gains, the taxpayer
must buy a property that is equal to or
higher in value than the one they sold.
 Example #1 - Fred and Sue sell their old
property for $100,000. The mortgage on
the property is paid off at closing, and the
balance of $60,000 is transferred to the
intermediary. If they buy their new property
for $90,000, they “bought down” by
$10,000. This “buy down” does not kill their
exchange, but the difference (between the
old sales price and the new purchase
price) of $10,000 is taxable. The IRS calls
this taxable amount boot.
Boot Issues
24

25. RULE NUMBER 6
 In order to defer all tax gains, the taxpayer
must buy a property that is equal or higher
in value than the one they sold.
 Example #2 - same facts as before, but
instead of buying the new property for
$90,000, Fred and Sue decide to buy a
new property for $150,000, for which they
obtain a loan for $100,000. This means
that they will only use $50,000 of the
$60,000 proceeds that the intermediary is
holding. The $10,000 excess is also boot
and is taxable.
Boot Issues
25

26. RULE NUMBER 6
 So your client has to think about
both:
 The price of the property sold
compared to the price of the
property to be bought.
 The amount of equity being put in
the new property compared to the
amount netted out of the sale.
Boot Issues
26

27. RULE NUMBER 6
 In other words:
 In order to pay zero tax, taxpayers
must do two things.
 They have to buy a property equal
to or higher in value than the one
they sold.
 They have to reinvest all of their
cash profits.
Boot Issues
27

28. RULE NUMBER 6
 No one can explain to me why the
taxable income is called “boot” in
1031 Exchange transactions, but I
have theories…
Reinvestment Target Issues
28

29. Reverse Exchanges
 A “Reverse Exchange” is when the property the taxpayer is
exchanging into is acquired first, before the sale of the
property the taxpayer is selling.
 Quite simply, the qualified intermediary acquires the property
first, and then the taxpayer exchanges into upon sale.
 Property owner cannot own the
“buy” and the “sell” properties
simultaneously. One property,
usually the replacement property,
must be ‘parked’ with the
qualified intermediary.
29

30. Reverse Exchanges
 Parking Issues
 Often, an experienced qualified
intermediary will not want the liability of
holding the property during the
exchange period.
 This often requires the creation of a
limited liability company (LLC) to own
the property until the exchange goes
through. The LLC must be owned by the
qualified intermediary until the exchange
goes through.
 Taxpayer does not get the tax
advantages of ownership while the
qualified intermediary owns it. 30

31. Reverse Exchanges
 Time Reversal
 Revenue Procedure 2000-37 outlines
a safe harbor for Reverse
Exchanges.
 Although not mandatory, it sets 45
days from acquisition of the
replacement property to identify the
relinquished property.
 180 days from acquisition of the
replacement property to complete
the exchange.
 The revenue procedure also gives 5
days after the acquisition of the
replacement property to complete
signature of the exchange
agreement.
But!!!!
Must be titled
in the exchange
agent when
acquired! 31

32. Reverse Exchanges
 Some of the situations that occur
that can turn an anticipated 1031
exchange into a Reverse Exchange:
 Owner finds a unique
opportunity to buy another
property before he gets his sold.
 Sale of the relinquished property
falls apart, and purchase of the
new property cannot be delayed.
 Property owner is overly
concerned about the time
deadlines and wants everything
resolved before he sells.
 Remodeling or construction
needs to be done to increase the
value of the replacement
property.
32

33. Reverse Exchanges
 Think about the cost of parking issues.
 Forming a business entity.
 Attorney’s fees for corporation.
 If time period is to go past the end of
the year, accounting and filing a tax
return for the business entity.
 Owner must finance the acquisition
of the replacement property before
selling the relinquished property.
 This often creates lender issues
because the lender does not like
the debt ratio of the taxpayer.
33

34. Like-Kind Requirement for Real
Property
 The like-kind
requirement for real
property is fairly easily
satisfied:
 All properties in the
exchange must be
considered real
property under
applicable state law.
 All properties in the
exchange must be
“held for productive
use in a trade or
business, or for
investment.”
34

35. Contract Issues
 Technically, to make the needed additions to the
sales contract required for a 1031 Exchange, you
should have an attorney draft the changes.
35

36. Contract Issues
 Generally, though, your contract needs
language added like this:
 If your client is the seller and he
wishes to do a 1031 Exchange out
of the property:
 “Seller intends to perform an
IRC Section 1031 tax deferred
exchange. Buyer agrees to
cooperate with Seller in such
an exchange. Buyer agrees to
an assignment of the contract
to a Qualified Intermediary
(Exchange Agent) to be chosen
by Seller.”
 If you represent the buyer, you
should add something like
 “Seller agrees that Buyer will
incur no cost or delay in
connection with Seller’s desire
to conduct a 1031 Exchange.”
36

37. Contract Issues
 If your client is buying in connection
with a 1031 Exchange:
 “Buyer’s purchase is in connection
with an IRC Section 1031 tax
deferred exchange. Seller agrees
to cooperate with Buyer in such an
exchange. Seller agrees buyer
MAY assign the contract to a
Qualified Intermediary (Exchange
Agent) to be chosen by Buyer.”
 If you represent the seller, you should
add something like
 “Buyer agrees that seller will incur
no cost or delay in connection with
Buyer’s desire to conduct a 1031
Exchange.”
37

38. Section 121 Exclusion
Capital gains tax on principal residences:
 First $500,000 of gain for married couples filing a joint return is not
subject to tax.*
 First $250,000 of gain for single taxpayers is not subject to tax (if a
principal residence for two of the prior five years).
 Gain in excess of the exclusion is subject to tax.
 For second homes, every dollar of gain is taxable.
 Section 121 Exclusion can be taken no more often than once
every two years.
 If property was subject to a 1031 Exchange, you must live in it FIVE
years to qualify for Section 121 Deduction.
What we are NOT talking about, but need to mention-
38

39. Caveat
 Uncle Sam can change the
law anytime he wants.
 It is possible to get into
long-term tax planning and
have the government
change the rules.
39

40. 40

41. Questions?
41