Section 1031 Requirements
Some of the most important requirements for an IRS approved 1031 exchange are the following:
The exchange process must be facilitated by a Qualified Intermediary:
The Qualified Intermediary (QI) is the professional executor of the mechanics of an exchange. They hold the proceeds from the relinquished property until they are reinvested in the exchange property. An "exchange agreement" must exist in writing between the QI and the investor in order to prevent the investor from having "constructive receipt" of the funds during the exchange period. Also, the QI is required to complete a valid 1031 exchange ensuring that all roles are followed and equity is preserved during the process. The use of a qualified intermediary as an independent party to facilitate a tax-deferred exchange is a safe harbor established by Treasury Regulations. It is very important that the investor select a qualified intermediary before they close on the relinquished property. Cornerstone can work with any authorized QI the client choses or we can suggest a nationally reputed, bonded QI to the client.
The properties must be “like-kind”:
This requirement is liberally construed and virtually all real estate properties, whether raw land or those with substantial improvements, qualify as like-kind. However, REITs, real estate funds, or other securities do not qualify for 1031 exchange. Types of like-kind properties may include:
- Raw Land
- Multi-Family Rentals
- Single-Family Rentals
- Retail Shopping Centers
- Office Buildings
- Industrial Facilities
- Storage facilities
The strict identification and timeline rules for a 1031 exchange must be followed to the letter:
- The investor must identify in writing the exchange properties within 45 days of the closure for the relinquished property in accordance with one of the following rules:
- Three-Property Rule: Identification of up to three properties regardless of the total value of property identified
- 200% Rule: Identification of any number of properties wherein the combined FMV (fair market value) does not exceed 200% of the relinquished properties' FMV
- 95% Rule: Identification of any number of properties regardless of the aggregate FMV, as long as at least 95% of the property is ultimately acquired.
- The investor must also close on the replacement property or properties within 180 days of the closure for the relinquished property.
The properties must be held either for productive use in a business or for the purpose of investment.
The replacement property must be of equal or greater value than the relinquished property.
The equity of the replacement property must be of equal or greater value than the equity of the relinquished property.
The debt held by the replacement property must be of equal or greater value than the debt held by the relinquished property unless the investor offsets lower debt on the replacement property by adding cash to the exchange.
All net profit from the relinquished property must be used in the purchase of the replacement property.