05/03/2022
1031 Exchange.
A basic premise of 1031 exchange is that the taxpayer who sells relinquished property must be the same taxpayer who buys replacement property. This usually means that the vesting is the same for both the relinquished and the replacement properties. For example, John Doe's name is on title to both properties involved in the 1031 Exchange.
However, there may be times when the party involved in the exchange would like to make a change in how the replacement property is held. For example, John Doe is on title to the relinquished property, but would like to take title to the replacement property in an LLC.
This is only allowable if the LLC is treated as a pass through entity, disregarded for tax purposes. The tax ID for the LLC will be the taxpayers social security number and there will be no need to file a separate return for the LLC.
This works for an LLC, but also for a revocable living trust, since living trusts can also be pass through entities for tax purposes.
1031 Exchange: Frequently Asked Questions
How long do I have to own my property before I can exchange it?
The longer the better. Unfortunately, there is no safe holding period for property to automatically qualify for an exchange. Keep in mind, the property only needs to be "held for investment" for it to be eligible for an exchange. Time of ownership is ONLY one factor at which the IRS looks at when determining if the property was "held for investment". In one private letter ruling (PLR 8429039), the IRS stated that a minimum holding period of two years would be sufficient. Although a private letter ruling does not establish legal precedent for all investors, there are many advisors who believe two years is a conservative holding period, provided no other significant factors contradict the investment intent.
Other advisors recommend that Exchangers hold property for a minimum of at least twelve months. The reason for this is twofold: (1) A holding period of 12 or more months means the investor will usually reflect it as an investment property in two tax filing years. (2) In 1989, Congress had proposed a one year holding period for both the relinquished and replacement properties. Although this proposal was never incorporated into the tax code, some believe it represents a reasonable minimum guideline.
Can I sell my duplex and purchase bare land?
Certainly. Properties involved in an exchange need to be held for either productive use in trade or business or for investment. Holding land for its future appreciation would be considered held for investment.
Can I purchase my replacement property first?
Yes; this requires that you do a reverse exchange however. The reverse exchange 'may' be an option provided you have the ability to structure the reverse exchange according to the safe harbor guidelines.
Can I move into a rental that I originally bought as part of 1031 Exchange?
Yes. However, please keep in mind that the property must first qualify for the 1031 Exchange. In determining if the property qualified the IRS will look at several factors including how long it was rented for and also your "intent". If the IRS feels your original intention when the property was acquired was to use it as a primary residence, you may have your exchange disqualified.
Do I have to reinvest ALL of my cash/equity?
No. However, any cash (equity) that is not reinvested in real estate will be taxable (and is known as cash boot).
How long do I have to complete my exchange?
180 days. However, also keep in mind you will be required to identify your potential replacement properties on day 45 of your exchange. Your timeline starts when you close escrow on the property you are selling.
Can I get an extension on my day 45 or day 180 deadlines?
No. The IRS only issues extensions in cases of a Presidential Disaster Declarations and the exchange has to have been directly affected by the disaster.
