A Guide to your §1031 Exchange:

In this explanation of a §1031 Exchange it may be easier if we give you the terminology involved with the transaction:

  1. You are the taxpayer or Exchanger.
  2. The property you are "selling" is considered the Relinquished Property.
  3. The property you are "buying" is considered the Replacement Property.
  4. Pennington Title Company is the Qualified Intermediary.

What is a §1031 Exchange?

A §1031 Exchange is a transaction in which a taxpayer is allowed to sell one property and buy another without a tax consequence. The transaction is authorized by section §1031 of the Internal Revenue Service Code. It is the best strategy for the deferral of capital gains tax that would ordinarily arise from the sale of real estate.

Why use a §1031 Exchange?

You may be spending more time than you want maintaining properties. You can exchange several properties into one in order to relieve the burden.
You may want to diversify and exchange for a property in another city or state.
You may want to exchange out one property that has a large amount of equity for several smaller properties. Exchanging into a tenants-in-common or triple-net lease property may be an alternative to consider.

What is Boot?

The term "boot" refers to any property received in an exchange that is not considered "like-kind." Cash boot refers to the receipt of cash. Mortgage boot is a term describing an Exchanger's reduction in mortgage liabilities on a Replacement Property.

How does it work?

A §1031 Exchange is usually a three-way delayed exchange, in which a Qualified Intermediary is used to facilitate the transaction. There are four basic steps:

  1. You arrange for the sale of your Relinquished Property and include exchange language in the contract.
  2. At closing, sale proceeds to go to a Qualified Intermediary.
  3. You identify potential exchange properties within 45 days of the closings.
  4. You complete the purchase of your Replacement Property within 180 days of closing.

How do you begin?

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First, consult with your tax advisor and/or attorney to determine if an exchange is appropriate for your circumstance and compatible with your investment goals. You must determine how to structure your exchange. Then, as your Qualified Intermediary, we will help you with the proper documentation and ensure safe investment of the exchange proceeds.

Once you have signed the purchase agreement, we can prepare the appropriate documents and set up your exchange. This should be done before you close on your Relinquished Property. Because the 45-day identification period tends to pass quickly, you will want to begin searching for potential Replacement Properties as soon as possible. Often exchanges are not completed because a desired Replacement Property was not identified in time. Don't wait - work with your realtor and start right away!

What are the Requirements?

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Exchanging Up:
To take full advantage of your §1031 Exchange, you should:

  1. Exchange your property for equal or greater value.
  2. Reinvest all of the net equity toward payment of the newly acquired properties or property.
  3. Acquire the same or a greater amount of debt with the Replacement Property.

Identifying Replacement Property:
§1031 regulations allow you to choose a Replacement Property by using any of the following three rules:

  1. Three Property Rule: Up to three properties no matter their value.
  2. 200 Percent Rule: Any number of properties as long as their combined fair market value does not exceed 200% of the fair market value of all Relinquished Property.
  3. 95 Percent Rule: Any number of properties no matter what the aggregate fair market value, provided 95% of the identified properties are acquired.

Like-Kind Property

Like-Kind Property refers to the type of property being exchanged. You can exchange any real estate investment for any other type of real estate investment. For example, vacant land can be exchanged for rental property.

The Qualified Intermediary

It is necessary to have a Qualified Intermediary to hold the proceeds safely until needed as the IRS stipulates you cannot be actual or constructive receipt of funds at any time during the exchange. Properly drafted intermediary paperwork is critical and defeats the problem of a taxable event in regard to the receiving the sale proceeds.

PENNINGTON TITLE COMPANY, as a disinterested party, qualifies for this role and has acted as a Q.I. since 1986. We are the only accredited member of the Federation of Exchange Accommodators in the State of South Dakota. Our professional and knowledgeable staff also includes the only Certified Exchange Specialist.

When broken down to its essence, there is nothing difficult about most exchanges. Sell then buy while rolling over your money with the proper paperwork and timing.

PENNINGTON TITLE COMPANY can assist you with your exchange wherever the real estate you are selling, purchasing, or exchanging is located. Our highly skilled staff delivers timely, knowledgeable service for transactions of any size and complexity. It's the service you're entitled to. Please email 1031exchange@penntitle.com for further assistance.