GENERAL 1031 EXCHANGE QUESTIONS
FGG1031 is an affiliate of First Guardian Group and is headquartered in San Jose, California. Our team consists of highly experienced real estate and investment professionals who have provided services to thousands of clients across the US for more than 12 years. At FGG1031, we specialize in providing a custom 1031 Exchange experience by working with the investor one on one throughout the entire 1031 Exchange process. We have the resources to sell your existing property and provide advice on selecting suitable 1031 Exchange options including replacement properties structured as a Delaware Statutory Trust (DST) as well as access to wholly owned real estate.
A property owner or investor who intends to purchase replacement property immediately after the sale of his existing property should consider an exchange. In a regular sale without an exchange, property owners will likely have to pay capital gain taxes in amounts which can exceed 30%, depending on the appropriate combined federal and state tax rates. In other words, when purchasing replacement property without the benefit of an exchange, your purchasing power is significantly less and will dramatically decrease the amount of wealth you can build in the long run.
Owners of investment and business property may qualify for a 1031 tax deferral. Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts, and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section 1031.
To accomplish a 1031 Exchange, there must be an exchange of business use properties. The simplest type of Section 1031 Exchange is a simultaneous swap of one property for another. Deferred exchanges are more complex but allow flexibility. They allow you to dispose of property and subsequently acquire one or more other like-kind replacement properties. To qualify as a 1031 Exchange, a deferred exchange must be distinguished from the case of a taxpayer simply selling one property and using the proceeds to purchase another property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property. Taxpayers engaging in deferred exchanges generally use exchange facilitators under exchange agreements pursuant to rules provided in the income tax regulations.
A reverse exchange is somewhat more complex than a deferred exchange. It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.
Both relinquished and replacement properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.
Both properties must be similar enough to qualify as “like-kind.” Like-kind property is property of the same nature, character or class. Quality or grade is irrelevant. Most real estate will be like-kind to other real estate. For example, residential properties can be exchanged into commercial properties which can then be exchanged into land. One exception is that property within the United States cannot be exchanged into properties outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.
No. Typically, exchange proceeds cannot be used to make improvements or pay debt on a property that is currently owned.
To defer the entire tax liability, a few requirements must be met. First, the replacement property must be valued equally or more than the relinquished property. This implies that all cash proceeds from the sale must be used towards the purchase of the replacement property. If there was debt tied to the relinquished property, an equal amount of debt must also be placed on the replacement property. The cash or other proceeds that you received is called “boot” and will be subject to taxes.
Constructive receipt refers to your possession or use of closing proceeds. An investor looking to defer capital gain taxes should avoid a constructive receipt. A properly executed exchange agreement with a Qualified Intermediary before the sale of the relinquished property will help ensure that you will not be in constructive receipt of the sale proceeds.
The IRS Regulations restricts on the number of properties which may be identified during the identification period. There are three rules for identifying property:
The “3-Property Rule”: Up to three properties without regard to the fair market values of the properties.
The “200% Rule”: Any number of properties, given that their aggregate fair market value as of the end of the identification period does not exceed 200% of the aggregate fair market value of the relinquished property sold.
The “95% Rule”: Any number of replacement properties with any aggregate fair market value, but only if the taxpayer ultimately receives identified property constituting at least 95% of the aggregate fair market values of all identified replacement properties before the end of the exchange period.
Any replacement property purchased before the end of the identification period is deemed to have been identified during the identification period. If a property purchased during the identification period is the sole replacement property being purchased, the regulations do not require a written identification. However, if it is not the only replacement property being purchased, it must be listed in a proper identification in addition to any other properties identified.
No. Unless the 95% rule must be satisfied, investors are not required to purchase all of the properties identified during the 45-days identification period. However, at least one of the identified properties will have to be closed for an investor to receive any tax deferral benefit.
You must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance except in the case of presidentially declared disasters.
The first requirement is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. Replacement properties must be clearly described in the written identification. The second requirement is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the relinquished property. The replacement property received must be the same as property identified within the 45-day identification period described above.
It is your choice on how much you wish to keep. However, the portion you decide to keep will be subject to potential capital gains and depreciation-recapture tax. Only the amount of funds received by the Qualified Intermediary and reinvested into replacement property will be tax-deferred. Please consult your tax advisor to further understand your potential tax liability before making decisions.
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A net lease requires the tenant to pay, in addition to rent, some or all of the property expenses that normally would be paid by the property owner. These include expenses such as property taxes, insurance, maintenance, repair, and operations, utilities, and other operating costs. These expenses are often categorized into the “three nets”: property taxes, insurance, and maintenance. In general, a lease where all three of these expenses are paid by the tenant is known as a triple net lease, NNN Lease, or Triple Net for short and sometimes abbreviated as NNN.
A DST investment provides many benefits which include lower minimum equity requirements, more simple and efficient closing process, protection against loan recourse liability, and greater security against rogue investors. More importantly, a DST investment may provide investors with the potential for “mail-box” passive income that contributes to building wealth. It eliminates management hassles for investors and avoid the need to provide tax returns to lenders.
A Delaware Statutory Trust is a separate legal entity created as a trust under the laws of Delaware in which each owner has a “beneficial interest” in the DST for Federal income tax purposes and is treated as owning an undivided fractional interest in the property. In 2004, the IRS released Revenue Ruling 2004-86 which allows the use of a DST to acquire real estate where the beneficial interests in the trust will be treated as direct interests in replacement property for purposes of conducting 1031 Exchanges.