A 1031 exchange, otherwise known as a tax deferred exchange, is a simple strategy and method for selling one property, that’s qualified, and then proceeding with an acquisition of another property (also qualified) within a specific time frame.
The logistics and process of selling a property and then buying another property are practically identical to any standardized sale and buying situation, a “1031 exchange” is unique because the entire transaction is treated as an exchange and not just as a simple sale. It is this difference between “exchanging” and not simply buying and selling which, in the end, allows the taxpayer(s) to qualify for a deferred gain treatment. So to say it in simple terms, sales are taxable with the IRS and 1031 exchanges are not.
1031s are sometimes called Starker Exchanges, named for the Starker Family of Corvallis who successfully took on the IRS. (T.J. Starker v. U.S., 431 F. Supp. 864 D. C. Ore. 1977 and (T.J. Starker v. U.S., 602 F. 2d 1341 9th Cir. 1979). You’ve gotta love that can-do attitude in Corvallis!
Successful 1031 exchanges have been elevated to a near art form, and a 1031 industry has evolved to support them. Some of our local title companies have 1031 services, and there is a specialized 1031 firm or two, even in Eugene. What follows is a general overview of important 1031 points, not a how-to encyclopedia.
You have 45 days to identify and 180 days to complete the purchase of replacement property.
Real property can be exchanged for other real property. The IRS doesn’t allow for 1031 exchanges of foreign property. At the time of this writing, Oregon allows 1031 for in-state to out-of-of state property, but at the time the out-of-state property is finally sold, you have to pay Oregon.
Apartments for raw-dirt, warehouse for single family houses, and single family houses for an office building are like kind. A partnership interest in exchange for real property is not like kind. Your shares in a REIT are not eligible for a 1031. Your finished lots in a sub-division are probably inventory, and not 1031 qualified.
A qualified intermediary must be used for your 1031 exchange. Your accountant, lawyer or family members are not qualified intermediaries.
There can be no net reduction of debt, and usually no cash out of the 1031 exchange, or you will have boot, which is taxable. The total value of your replacement property should equal or exceed the value of the relinquished property, or there will be a tax liability.
Replacement Property Rules
To prevent investors from identifying every piece of property in the United States as replacement property, there are rules about what you can identify for a successful 1031 exchange.
You may identify any three properties regardless of their values.
You may identify any number of replacement properties if the total value of the replacement property you end up with is at least 95% of the Fair Market Value of the total properties identified.
You may identify any number of replacement properties if their total value doesn’t exceed 200% of the total value of replacement properties you end up with.
Types of Exchanges
This is the traditional exchange. First you make the sale, then you find and buy the replacement property, through a qualified intermediary.
The replacement property is first purchased through a qualified intermediary, then the relinquished property is sold.
The qualified intermediary advances funds to build a new structure or remodel an existing one.