Important 1031 Exchange Guidelines

The IRS has issued guidelines to enable tax payers implement them and take the capital gains tax deferment benefit under section 1031 of the income tax laws. These are known as 1031 Exchange Guidelines. They apply to forward, concurrent, reverse, leasehold improvement, or build-to-suit property exchanges under section 1031 of the income tax laws.

The tax return (and the name of the tax payer that appears on it) that specifies the sale of the relinquished property must match with the tax return (and the name of the tax payer that appears on it) that specifies the purchase of the replacement property. Further, the names on both these should also match with each of the names on the titles of the relinquished and replacement properties respectively

The tax payer must invest at least the sale value proceeds of the relinquished property in the purchase of the replacement property to take 100% capital gains tax benefit. In case the sale value of the relinquished property is more than the purchase value of the replacement property, capital gains tax will be leviable on the difference between the sale value and the purchase value.

The only exception to this is if the Qualifying Intermediary holds the net cash proceeds of the two transactions and does not transfer them to the tax payer.

The tax payer (known as the Exchanger) has a period of 45 days after the date of sale of the relinquished property to identify potential replacement properties to the Qualifying Intermediary.

In the case of a reverse exchange, the Exchanger has 45 days in which to make the identification of the relinquished property (to be sold). The Exchanger also has 180 days after the date of purchase of the replacement property to sell the relinquished property.

The Exchanger needs to identify a maximum of three replacement properties, the cumulative value of which is equal to or greater than the value of the relinquished property.

Further, the Exchanger may identify any number of replacement properties with the restriction that their cumulative value must not exceed 200% of the value of the relinquished property. Further, if they exceed that value, the Exchanger must close on at least 95% of them before the end of the 180 days replacement property purchase deadline.

The Exchanger must purchase the replacement property within the 180 days from the date of sale of the relinquished property.

The 1031 Exchange Laws do not cover any clause on the time for which a property has been owned by a tax payer before relinquishment. However, the IRS always checks this time to know the intent of the tax payer. In case the property has been held for only a short period, the tax payer’s intention to own the property solely for investment is suspect.

Some other aspects of the 1031 Exchange Guidelines include whether the property relinquished was itemized on Schedule E and whether it was rented.

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