GUIDE TO SECTION 1031 EXCHANGES

March 17th, 2017 by JBWK

Submitted by Conway H. Sheild, III.

I continue to receive questions from people who are somewhat confused about the time limitations that go along with a Section 1031 Exchange, which is an exchange of like-kind investment property so that the tax on any gain can be deferred. While a simultaneous exchange is one where the exchanger transfers the relinquished property and acquires a replacement property at the same time, this often is not possible as the relinquished property and the replacement property are not available at the same time. The rules involving Section 1031 of the Internal Revenue Code permit non-simultaneous exchanges and the amendments imposed a forty-five (45) day identification requirement and a one hundred-eighty (180) day exchange period requirement. Most people, who are exchanging such property, struggle with the forty-five (a5) day identification period. The rule under Section 1031 is that any property received by the taxpayer will not qualify for exchange treatment if such property is not identified as property to be received in the exchange on or before the day which is forty-five (a5) days after the date on which the taxpayer transfers the property relinquished in the exchange. Section 1031 also provides that the tax payer must close on all replacement property within the earlier of (i) one hundred eighty (1S0) days of closing the relinquished property, or (ii) the due date of the taxpayer’s tax return in question (with extensions). Exchangers who need more than one hundred eighty (180) days from transfer of the relinquished property to acquire a new replacement property may extend the due date of their tax return to obtain additional time, and therefore exchangers rarely struggle with the one hundred eighty (180) day exchange period.
Since the regulations permit tax payers to identify three or more replacement properties and choose at a later date which property or properties to acquire as the actual replacement property, the exchangers can take more than forty-five (45) days for due diligence conduct to select which property will actually be exchanged. Thus, the only really hard date that will be tough to comply with would be the forty-five (a5) day period of identification of qualified property.
The regulations also created a “safe harbor” permitting qualified intermediaries to hold exchange proceeds for exchangers. These intermediaries provide a vital role in the exchange process by holding exchange proceeds and typically serve as the recipient of ID notices. The one rule about qualified intermediaries which cannot be violated is that they must be totally independent of the parties involved in the exchange, and their only connection can be the fact that they have engaged to be the qualified intermediary.
There are, however, certain rules in the identification of potential replacement property, which are, simplistically, as follows:
1. The Three Property Rule: Three properties of any value. This is the simplest ID rule.
2. The 200% Rule: Any number of properties, as long as their aggregate fair market value as of the end of the identification period does not exceed 200% of the aggregate fair market value of the relinquished properties as of the date they were transferred by the taxpayer. This rule is obviously more complex.

3. The 95% Exception Rule: Any number of properties can be identified, but only if the tax payer receives, before the end of the exchange period, identified replacement property the fair market value of which is at least 95o/o of the aggregate fait market value of all identified replacement properties. This rule is infrequently used for obvious reasons, as is the 200% rule; they require some complex computation and can be, if handled wrongly, subject to challenge by the IRS.
While the Section 1031 Exchange can in fact be helpful from a tax perspective, certain preliminary planning should be done before entering into this transaction to ensure that you are compliant with the rules and will not face an IRS challenge. Our firm is conversant in how to handle these exchanges, and can in fact also find a qualified intermediary for these transactions.

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