As we’ve mentioned in previous blogs, the 1031 exchange is a method to potentially defer capital gains taxes on the sale of real estate used for trade or investment. Through the process, you “swap” the real estate you currently own into other real estate of equal or greater value.
There is a great deal of terminology connected with the 1031 exchange. Some of the more important terms involved with the process are listed below.
1031 Exchange/Like-Kind Exchange. This comes from the 26 U.S. Code § 1031 – “Exchange of Real Property Held for Productive Use or Investment.” “Like-kind” can consist of any real estate property, as long as it will be held for investment or business purposes.
Acquisition Costs. These are the transactional costs involved in the like-kind exchange. They can include legal fees, escrow, transfer taxes, appraiser fees, and closing costs.
Basis. Also known as cost basis, this is the original purchase price (or cost) of investment properties, plus additional costs involved with the acquisition. Additional “basis” terminology important to a 1031 exchange includes the adjusted basis, which includes additional costs involved with the asset, which can include capital improvements and some legal or impact fees.
Boot. Boot is the remaining extra cash or non-like-kind property that might be left over from your exchange. This can include debt relief or installment notes. Boot is subject to immediate taxation.
Exchange Period. This gives you 180 days from the time you close on your relinquished property to complete the acquisition of your replacement property or properties.
Exchangor/Exchanger. This is another name for the taxpayer or owner of the properties being exchanged in a 1031 exchange process.
Identification Rules. These outline the potential replacement property requirements (through the Three-Property Rule, 200% Rule, or 95% Rule). They also outline how to report identified replacement properties to the IRS.
Identification Period. Under the 1031 exchange, you have 45 days from the time you close on your relinquished property to target a replacement property or properties.
Qualified Intermediary. Also called a 1031 Exchange Accommodator, the QI is an important part of the exchange process. These entities take responsibility for the paperwork involved in the process, as well as holding funds in escrow from the sale of relinquished assets.
Qualifying Property. The real estate eligible for a 1031 exchange. This includes land and buildings.
Replacement Property. The property you want to purchase or acquire as part of the 1031 exchange.
Relinquished Property. The property you want to sell as part of a like-kind exchange.
Keep in mind that the above are only some of the terms you will run across if you decide to participate in a 1031 exchange. There are many more terms – and regulations – involved with a successful exchange. It’s important to work with a tax professional or other qualified expert to ensure a seamless exchange, from start to finish.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
