Specializing in Tax-Deferred Property Exchanges


1031 Exchange FAQ

Q:  What property is like kind to my property?

When it comes to real estate generally, all property is  like kind to all other real estate. For example, farmland can be  exchanged for an office building or a condominium can be exchanged for a  trailer park. The state law of the jurisdiction in which the property  is located will define the definition of what is an interest in real  estate, such as mineral interests, water rights, etc. Our business  focuses on exchanges of real estate and exchanges of certain other  tangible personal property, like airplanes, equipment, and livestock can  be exchanged. Whether personal property is like kind is determined by  reference to certain depreciation classifications. We can handle  exchanges of real estate or personal property.


  Q:  What must I do to have a fully deferred exchange?

The general rule is that, in order to have a fully tax  deferred exchange, the exchanger must trade equal or up in equity and  debt. The effect of this rule is that the exchanger must use the entire  net proceeds from the relinquished property as down payment on the  replacement property. Also, the exchanger must replace any mortgage paid  off at the sale of the relinquished property with an equal or greater  mortgage on the replacement property. Any cash received by the exchanger  whether at the sale of the relinquished property or at the purchase of  the replacement property will be deemed "cash boot" and tax will be  recognized to the extent of gain. This rule applies regardless of the  exchanger’s cash position in the relinquished property. Regardless of  the size of the exchanger’s down payment, principal pay-down, or capital  improvements on the relinquished property, the exchanger will be  treated as having received "cash boot" if cash is received as part of  the exchange. The fair market value of the relinquished property can be  calculated by subtracting from the selling price the ordinary and  customary transaction costs of the sale. These transaction costs are  limited to those costs directly related to the sale of the relinquished  property. The most common transaction costs are brokerage fees, title  insurance fees, exchange service fees, and recording fees.


  Q:  May I have a partially tax deferred exchange?

If the rule described in the answer above is violated, a  partially tax deferred exchange is the likely outcome. If the exchanger  trades down in either debt or equity then some gain is likely to be  recognized. If the exchange portion of the transaction is otherwise  valid, a partially deferred tax exchange is the result.


  Q:  What is boot?

"Boot" is anything of value received by the exchanger, which is not "like-kind" to the relinquished property.

  Cash Boot

If the exchanger receives cash upon sale of the relinquished  property this will be treated as "cash boot" and tax will be recognized  to the extent of gain in the transaction. For example, if the QI  receives $40,000 upon sale of the relinquished property and the  exchanger elects to receive $10,000 in cash at closing, the exchanger  will pay tax on $10,000 while the exchange is completed with the  remainder of the funds held by the QI.

  Mortgage and other boot

If the exchanger fails to purchase a replacement property of  equal or greater value than the relinquished property there is a strong  possibility that he will be deemed to have received "mortgage boot."  For example, if the exchanger relinquishes a property valued at $100,000  and deposits $50,000 with their QI and a $50,000 mortgage is paid off,  then replaces with a property valued at $90,000 with $50,000 cash down  and a replacement mortgage of $40,000 the exchanger will pay tax on  $10,000. This is an example of the receipt of "mortgage boot." An  exchanger can also receive other property, which will be deemed boot.  For example, if the exchanger receives an automobile, artwork, or any  other thing of value as part of an exchange, that other non-like kind  property will be deemed boot and taxed on the fair market value  allocated to it.


  Q:  Can I refinance a property immediately prior to the exchange?

Recent tax authority suggests that a refinancing of the  relinquished property prior to sale with receipt of cash by the  exchanger may not be deemed "cash boot" under certain limited  circumstances. This course of action is not generally recommended. In  the event the exchanger needs cash for a bonifide independent business  purpose, it is strongly recommended that the exchanger refinance the  replacement property after acquisition and when the independent need for  cash arises.


  Q:  How long do I have to identify, how do I identify, what constitutes sufficient identification, is there any leeway?

The replacement properties must be identified within 45  days after the closing on the sale of the relinquished property. This  requirement is strictly enforced, even if the 45th day falls on a  holiday. Identification must be in writing, signed and dated by the  exchanger and received by the QI no later than 45 days after the sale of  the relinquished property. Replacement property must be identified  unambiguously. Usually either a legal description or a mailing address  is sufficient. Beware of an exchange where an exchanger identifies a  property in whole and then closes on only a part of the whole. If  challenged, this may be an insufficient identification for a successful  exchange.


  Q:  How long do I have to purchase my replacement?

The replacement property must be purchased and closing  complete within 180 days after the transfer of the relinquished  property.


  Q:  May I do a multiple leg exchange?

Yes, several relinquished properties may be exchanged  for a single replacement property. One relinquished property may be  exchanged for several replacement properties. The important thing is  that the exchange be part of a unified exchange agreement from the  beginning. The 45-day identification rule and 180-day replacement rule  will start running from the date of the sale of the first relinquished  property. Sometimes because of this timing issue it is better to  structure the exchange as a series of exchanges rather than a multiple  leg exchange.


  Q:  May I exchange less than 100% of my interest?

Yes, a fractional part of the relinquished property may  be exchanged and/or a fractional part of the replacement property may be  acquired.


  Q:  How should I take title to replacement property?

Title to the replacement property must be taken in the  same name in which the relinquished property was held. Caution dictates  that this rule is followed even when husbands and wives are involved.


  Q:  What is a related party and can I do an exchange with them?

This is an evolving area in 1031 exchanges. Generally  speaking, if an exchange occurs involving related persons or entities  then all exchanged properties must be held by the exchanger and the  related party for a period of two years after the date of the last  transfer or the exchange will not qualify for tax deferral. Related  parties are defined as: lineal ancestors and descendants, brothers and  sisters and business entities in which the exchanger owns at least a 10%  interest. In a deferred exchange, the exchanger may acquire property  from a related party as long as tax avoidance is not an issue.


  Q:  Do I receive a tax basis in my replacement property?

No, tax basis from the relinquished property is carried  forward into the replacement property. Any additional cash investment or  increase in a mortgage by the exchanger increases tax basis in the  replacement property. Once a depreciation allowance is taken on the  relinquished property it may not be used a second time on the  replacement property. This rule is generally regarded as a negative  consequence of a 1031 exchange. Both investors and brokers frequently  misunderstand it.


  Q:  Can an entity do an exchange? Corporation, partnership, LLC, trust

Yes, title to the replacement property must track with  the relinquished property. A partnership interest in one partnership may  not be exchanged for a partnership interest in another partnership. A  share of stock in one company may not be exchanged for a share of stock  in another company. However, legal entities may perform exchanges under  1031.


  Q:  Can I receive title to replacement property before giving up title to relinquished property?

Reverse 1031 exchanges are permitted. However, the  exchanger may not hold title to both properties at the same time.  Instead an Exchange Accommodation Titleholder must hold title to one of  the properties. Contact us for more detail.

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  Q:  Can I use exchange funds to pay down mortgage on property I already own?

  A:  No. The IRS does not consider this a like kind exchange.


  Q:  Can I use exchange funds to do fix up on replacement property?

It is generally best to have the owner of the  replacement property perform the fix up prior to acquisition of the  replacement property. As a second alternative, it is better to use funds  other than exchange funds to perform the fix up on the replacement  property. Finally, exchange funds can be used to perform fix up on the  replacement property if the fix up is accomplished prior to the  exchanger actually acquiring title.


  Q:  Can I use exchange funds to build improvements on replacement property?

Generally speaking the best way to accomplish this goal  is to have a "Special Purpose Entity" acquire title to the replacement  property, have the Special Purpose Entity build the improvements, and  have the exchanger acquire the replacement property from the Special  Purpose Entity under the regulations for exchanges. Please contact us if  you are asked to perform a construction exchange. (Link to Contact  Page)


  Q:  As an closing agent, what do I do when I am notified that  a party to a transaction I will be closing, intends to do a 1031 Tax  Deferred Exchange?

If you are notified, either verbally or in the Buy-Sell  Agreement, that a party to the Agreement wants to do an exchange, you  must include the "language" in your closing escrow instructions to the  effect that Buyer agrees to cooperate with Seller, or Seller agrees to  cooperate with Buyer, or Buyer and Seller agree to cooperate with each  other. American Equity Exchange is pleased to provide you with sample  language if your company needs it.

  Remember, if you have placed  "exchange intent language" in your  closing escrow instructions and are subsequently notified that the  party will not be doing an exchange, you must prepare an amendment  deleting that clause so it does not appear as if you closed and forgot  to do the exchange.


  Q:  When do I need to notify the Exchange Intermediary Company of my involvement in a transaction?

Typically you will contact American Equity Exchange  after sale or purchase contingencies (i.e. physical inspection,  environmental assessments, title review, etc.) have been removed. If you  have a very quick closing escrow, do not wait for the contingency  period to be removed, notify our office immediately. Otherwise, after  contingencies are removed, you need to immediately furnish our office  with a copy of the Buy-Sell Agreement, Title Commitment, and info on who  will be the closing agent on the transaction.


  Q:  What does American Equity Exchange do after they receive  the Buy-Sell Agreement & Title Commitment from the Closing Agent?

Upon our receipt of the Buy Sell Agreement and Title  Commitment, we will then prepare our Exchange Agreement and Substitution  of either Buyer or Seller for your use in the escrow. Our exchange file  is then set up to coincide with how your escrow is structured (see  notes below as to the percentage interests; Purchase Money Mortgages  etc.). We then forward the documents to the Closing Agent. Please return  the documents to our office as soon as the signatures are obtained.

  From the point in which the Substitution of Buyer or Seller has  been prepared, American Equity Exchange is then your Buyer or Seller.  This means that any subsequent amendments, etc. that require the party’s  signature must show American Equity Exchange in addition to the  original parties. If American Equity Exchange is not specified in the  documents, you are jeopardizing the exchange transaction.

  So remember, place American Equity Exchange’s name in place of  the Exchangor’s, as the principal, and have the Exchangor merely  "acknowledge receipt" of all subsequent instructions. This rule applies  if you are canceling or superseding your escrow instructions.


  Q:  As the Closing Agent, how do I handle the estimated closing statements?

American Equity Exchange will show as either the Buyer  or Seller. You will send us the Estimate for our approval with a copy of  the Exchangor's acknowledgement of same on the bottom. We cannot sign  until this acknowledgement is received. Additionally we must receive the  final closing statement immediately upon escrow closing showing our  name as principal together with any other documentation requested in our  instruction letter. We cannot complete our exchange file without these  items.


  Q:  As the closing agent, how do I handle the money received and/or disbursed from the closing escrow transaction?

In the event your Buyer is the one doing an exchange  that means that American Equity Exchange is already in receipt of  exchange funds. You must contact our office to see if the initial  deposit is coming from us as Intermediary or if the Exchangor/Buyer will  be depositing it directly. Often the Buyer will need to come up with  money in addition to the exchange proceeds to complete the purchase.

  If American Equity Exchange gives you the initial deposit, you  should show us on the receipt and your original Closing Escrow  Instructions. However, most of the time, you will be receiving an  initial deposit directly from the Exchangor/Buyer and they will be shown  as the Buyer until American Equity Exchange has been substituted in as  Buyer at a later date.

  CAUTION: In this event, your closing statement will need  to show a line item as "return of initial deposit to Exchangor" in order  to clarify to IRS that the Exchangor did not have any constructive  receipt of funds. Furthermore, any and all proceeds and/or refunds that  you prepare in your escrow must be made payable to American Equity  Exchange, even if they are after the close of escrow or you will  jeopardize the exchange. Remember that once American Equity Exchange is  substituted in as either buyer or seller, American Equity Exchange is  the principal. This is very important to remember so that you always  keep our office informed.


  Q:  How do we handle the situation where the Seller is doing  an Exchange and they will be carrying back a note and deed of trust or  mortgage?

In this situation, you must communicate clearly with the  Exchangor/Seller, their tax advisor, and our office as to the proper  structure of the transaction. If the trust deed or mortgage is to be  part of the Exchange, you will show American Equity Exchange as your  Beneficiary. Then, through our exchange file, we will handle the  assignment of same to the Exchangor/Seller or to whomever it will  eventually be assigned. Sometimes the trust deed or mortgage will roll  into the Exchangor's "replacement property." If the trust deed or  mortgage is not to be a part of the Exchange (typically because the  Exchangor/Seller elects installment sale treatment for the trust deed or  mortgage) then it is very important that your closing statement reflect  the percentage interests and that you prepare an amendment in your  closing escrow regarding same.


  Q:  What is the Qualified Holding Period for a property that was purchased through a 1031 exchange?

There is no hard & fast role on this subject. Many  people believe two years is necessary. The taxpayer has to intend to  hold the property for investment or income producing purposes when the  property is acquired. If there is a bona fide intent to meet the holding  requirement, the qualified use period may be less. The taxpayer should  consult with their tax advisors on their issue


  Q:  How much do I need to spend of the exchange value to receive full non-recognition of capital gain?

To receive full non-recognition of capital gain you need to spend equal or greater the amount of the exchange value.


  Q:  When selling a piece of property can it be vested differently than when buying a piece of property?

No, when doing a 1031 exchange the vesting in the  replacement property must be the same as the vesting in the relinquished  property.

Washington State Senate Bill 6295:  "Washington state law, RCW 19.310.040, requires an exchange facilitator to either maintain a fidelity bond in an amount of not less than one million dollars that protects clients against losses caused by criminal acts of the exchange facilitator, or hold all client funds in a qualified escrow account or qualified trust that requires your consent for withdrawals.  All exchange funds must be deposited in a separately identified account using your taxpayer identification number.  You must receive written notification of how your exchange funds have been deposited.  Your exchange facilitator is required to provide you with written directions of how to independently verify the deposit of the exchange funds.  Exchange facilitation services are not reguluated by any agency of the state of Washington or of the United State government.  It is your responsibility to determine that your exchange funds will be held in a safe manner."