1031 Exchange Rules
Confused by 1031 Exchanges? You are not alone - the whole process can be very frustrating for many of us. We will try to help by providing you with some 1031 Exchange Rules and Guidelines. Following are just a few of the most important pieces of the puzzle.
There are time limits to bear in mind when entering into a 1031 Exchange. A maximum of 180 days from the closing on the relinquished property, or the due date of that year’s tax return, (whichever occurs first) to the acquisition of the replacement property. The first 45 days is called the Identification Period. Before the expiration of the 45 days, the \“Exchanger\” must identify the property to be used for replacement.
What properties qualify for a 1031 Exchange? Only certain types of property qualify for a 1031 Exchange. Both the relinquished property and the replacement property must be held either for investment or for productive use in a trade or business. What properties do not qualify for an Exchange? A personal residence, for one example, does not qualify. Additionally, the asset must be of \“like kind\”. Real property must be exchanged for real property and personal property must be exchanged for personal property. Real Property - includes land, commercial property and residential property Personal Property - includes livestock (of the same sex), farming equipment, machinery, to name a few.
In order to qualify, a replacement property for a 1031 exchange must comply with one or more of the following requirements:
The Three Property Rule: The three property identification rule allows the Exchanger to identify up to three potential replacement properties.
The 200% Rule - Any number of properties may be identified as long as the aggregate fair market value of the replacement properties does not exceed 200% of the aggregate Fair Market Value of all of the exchanged properties as of the initial transfer date.
The 95% Exception Rule: If the Exchanger identifies replacement properties that exceed the three property rule and the 200% of fair market value rule, the identification will still be considered valid for 1031 exchange treatment if the Exchanger acquires at least 95% of the property value identified.
The funds from the transactions must be handled by a Qualified Intermediary. The Qualified Intermediary (QI) plays a very important role in a 1031 exchange and serves a variety of functions which we detail on another page. Very basically, a QI provides the service of holding the proceeds and preparing the documents for the 1031 transaction. They do not provide legal or tax advice to the exchanger.