There are Four Primary Requirements for a fully tax deferred exchange:
Purchase “Like-Kind” Property (Any class of Real Property: Residential, Commercial, Multi-family, Land, etc.)
Reinvest all Exchange Proceeds from the Relinquished Property into Replacement Property
Purchase property Equal or Greater in value to the Relinquished Property
Acquire new Debt (Mortgage) equal or greater in value to Debt relieved (Debt can be offset by cash)
I. Sell and Purchase “Like Kind” Property
Only real property held for productive use in a (i) trade or business or (ii) for investment qualifies under the section 1031. Primary homes, vacations homes, and “flippers” do not fall under section 1031.
The term “Like-Kind” Property includes:
Residential, Commercial, Industrial, Retail, DST
Condo, Multi-Family, Apartment Building
Raw, farm, or agricultural land
Ranch
30+ year leasehold
Any Real Property that is used as Rental Property or for Business purposes
An exchanger may sell out of and purchase into any of the above properties. For example, an exchanger may sell a single family residential home and purchase a commercial property, or vice-versa.
II. Reinvest Net Earnings From Sale Into Replacement Property
For a fully tax-deferred exchange, the exchanger must reinvest all the net earnings from the relinquished property (sale) into the replacement property (purchase). Any earnings from a sale that are not reinvested into a replacement property are considered boot and subject to tax. This is considered a partial deferral. Partially deferred exchanges are viable and do not nullify the integrity of an exchange.
III. Purchase Replacement Property at Equal or Greater Value
For a fully tax-deferred exchange, the exchanger must purchase replacement property equal or greater in value to the relinquished (sale) property. In determining this figure, however, the IRS permits an exchanger to subtract allowable costs such as real estate agent commissions, title and escrow fees, and exchange fees. The sale value minus these allowable costs will indicate the ‘target value’ for the exchanger to achieve.
If the exchanger does not replace the target value in the exchange, the short fall is considered the new taxable gain. For example, if an exchanger sells a $500k property and factors in allowable costs of $25k, the exchanger determines he must purchase replacement property at $475k in value (the target value). If, however, the exchanger can only successfully purchase property at $400k, this $75k difference becomes the new taxable gain.
IV. Acquire New Debt or Mortgage at Equal or Greater Value
When performing a 1031 exchange “swap”, it is important to remember that in order to defer all of the capital gains taxes on the sale transaction, the exchanger must also trade across in debt “mortgage”. In simple terms, if the exchanger had a mortgage paid off from their sale, they must acquire a new mortgage on the replacement property at equal or greater value. The only alternative to acquiring debt is replacing it with cash giving an exchanger the ability to offset their debt requirement with personal cash. The IRS will not recognize the gain from the sale as long an exchanger trades across or up in Value, Equity and Mortgage.
CR Capital 1031, LLC does not provide tax or legal advice, nor can we make any representations or warranties regarding the tax consequences of your exchange transaction. Exchangers must consult their tax or legal advisors for advice and clarification on tax rules.