The Dirty Dozen Basic Rules of Section 1031
$695 FOR MOST EXCHANGES (1
RELINQUISHED, 1 REPLACEMENT) + $295/ADD’L PROPERTY
Section 1031 of the Internal Revenue Code, which authorizes Tax Deferred
Exchanges, is one of the most powerful sections in the Federal Tax Code. Section 1031 allows you to legally
avoid/defer paying thousands of dollars in current Capital Gains Taxes when you sell one investment property and
roll the proceeds into a replacement property. In order to take advantage of this statute, exchange documents
must be in place before you close on the property you are selling and you need to use a Qualified Intermediary
(“QI”), which is the role of BlackAcre 1031. You cannot do a 1031
exchange on owner-occupied property – and you do not need a QI in that case. For owner-occupied property, there
is a different rule which, under certain circumstances, allows an individual Taxpayer a $250,000 gain without
paying any taxes.
For this worksheet, we call the property you sell the
“Relinquished Property” or “RQ” and each property you buy is called the “Replacement Property” or “RP.” A
Section 1031 Tax Deferred Exchange allows you to legally avoid/defer most or all Federal and State Capital
Gains Taxes if you sell property (the “Relinquished Property” or “RQ”) that is “held for productive use in a
trade or business or for investment” – rental real estate, for example, and buy other investment real
property, the RP. NOTE: This information may appear in a simplified form for illustrated purposes. An
Exchange is a very sophisticated transaction. Get professional legal/tax advice and please read the
disclaimer at the bottom of this flyer.
1. A valid exchange requires proper exchange documents in place to
prove intent, to prevent constructive receipt, to provide an accommodating party BEFORE
2. Taxpayer cannot have actual or constructive receipt of the
funds. – The Settlement Agent wires your exchange funds directly to Commerce Bank (NYSE-CBH &
S&P500), which performs our Treasury function and keeps your funds safe in a segregated account with your
name on it. You go shopping for property in your own name (or already have one under contract).Then, at your
Replacement Property settlement(s), BlackAcre wires the funds directly to your Replacement Property Settlement
3. Same Taxpayer that sells must be the Taxpayer (“TP”) that
buys. This rule follows the titleholder not the maker on the note. If title held by an entity, entities can
do exchanges. Sometimes members of LLC or LP want out. Planning as long beforehand is key here or you might need
alternative strategies. Sometimes Wife is titleholder and she wants to buy Replacement in name of Husband and
Wife. Call to discuss this fact pattern, too. For the entity, you may choose to pay partners from other funds –
planning is key. For Husband and Wife, you may need to wait until exchange is old and cold before putting in
4. Trade up or trade even (“TU/TE”). In order to be completely tax
deferred, TP must trade up or trade even in debt (or add new cash) and trade up or trade even in their equity –
less allowable exchange expenses. RQ example in No. 1, above, has $800K in debt and sells for $2MM. If RP =
$1.9MM and is acquired with $700K debt and all $1.2MM in exchange funds, you fail to TU/TE in debt and take
$100K in taxable gain, taxed at 25% state+State rate – Note: Land is not depreciated and would be taxed at LTCG
rate of 15%. IF RP = $1.9MM and is acquired with $800K debt and $1.1MM in exchange funds, you fail to TU/TE in
equity and take $100K in taxable gain. If TP bought RP for $2MM with $1.2MM exchange funds and added $800K in
new cash, no gain. When you add in “allowable exchange expenses” such as transfer, recordation costs, brokers
fees, exchange fee, etc…, in the real world, with $150,000 in allowable exchange expenses, one might only have
$1,050,000 in exchange funds and one can meet TU/TE with a $1,850,000 RP.
5. Qualified property must be held for a qualifying
purpose. Qualified Property: Statute disqualifies “stock in trade or other property held primarily for
sale; stocks, bonds, notes; other securities; interest in a partnership or multi-member LLC, certificates of
trust or beneficial interest. Quick-turn or “flips” or buy/fix-up/resell property may be inventory or “held
primarily for sale” and the exchange may not be effective. Proper planning may help. Time owned is one key
factor. Properly structured, a percentage interest held as a tenant in common is qualified property. Qualifying
Purpose: “held for productive use in a trade or business or for investment.” Not TP’s residence – use Section
121; Not dealer or resale property; vacation property may be OK if rented for fair market value (“FMV”) or held
primarily for investment rather than personal use. Professional planning will mean the difference on this
6. Notice of Identification – 45 days. Within 45 days of settlement
of RQ, in a writing signed by TP, TP must narrow choice of RP and comply with EITHER (1) 3 property rule; OR the
(2) 200% rule; OR the 95% rule. The 3 property rule does not inquire into the value of the property – you may ID
3 properties regardless of value. The 200% rule does care about value as a limit on how much TP can identify.
The 200% rule states that you may identify any number of properties up to 200% of the fair market value of the
RQ. Anything closed on within the 45 days is presumed identified.
7. Notice of Identification – Formal Document. By midnight on Day 45,
TP must provide Notice to BlackAcre – (1) in writing; (2) unambiguously ID RP; (3) signed by TP; and, (4) sent.
We use the date and time stamp on the fax machine, usually. TP doesn’t have to have the RP under contract for
1031. The 45 day rule is a hard rule written in statute. Expect no exceptions.
8. Like-Kind property – Very broad categories for Real
Property. Basically any property for any other real property. Condo for Shopping Center for Office uilding
for Single Family Home for townhouse for industrial for raw land are all OK if the Real Property is held for
Qualifying Purpose. See Rule 6, above.
9. Close before midnight on Day 180 or when tax return is due,
including extensions. Measure Day 180 from RQ settlement date.
10. Call for info about reverse exchanges, build-to-suit or
improvement exchanges, TICs and other varmints.
11. How much can the investor save? Advanced example: Avoid or defer
unlimited Fed & State Capital Gains Taxes. [Gain=Sales Price – Allowable Exchange Expenses – Adjusted
Basis.] The Fed Recapture Rate still = 25%; Long Term Capital Gains (LTCG) is 15%. Assume a State Tax Rate of
5%. Recapture = 30% (25% Feds + 5% State) and LTCG = 20% (15+5). The amount that must be “recaptured” is the
amount you have depreciated. Land is not depreciated. Simplified Example: Property bought for $1MM ten years
ago, no capital improvements and depreciated at $25K/year – total Depr = $250K, basis is now $750K. Ignoring
transaction costs, if sold for $2MM, tax due = [$250,000 x 30%] + [$1MM x 20%] = $75,000 + $200,000 = $275,000.
Avoid that w/1031! Basis in RP if RP costs $3MM. First $2MM – Basis = $750K, next $1MM, basis = $1MM. New Basis
in $3MM property = $1.75MM. Note: Debt is not relevant to this calculation. Basis is the
12. How much does it cost? For $695, BlackAcre will provide you
professional services, prepare the legal documents and perform the escrow function on one RQ and one RP. Each
additional transaction is $295. Repeat until rich!! Nationwide, bonded and insured, we have done more than $1.5 billion in
exchange transactions. Your funds are kept safe at Commerce Bank (NYSE – CBH) and we are here to make your 1031
exchange easy! You can find someone cheaper online, for sure – should you? I don’t think so! ? Is it a wise
choice to try to save a hundred bucks and risk the integrity of your exchange? I don’t think so! ? Are they
going to take as good care of you as we are at BlackAcre 1031? I don’t think so! ? If you call someone else, are
you going to get to work with an attorney directly on your exchange? I don’t think so! ? Should you call anyone
other than BlackAcre 1031 to act as Qualified Intermediary for your exchange? I don’t think so.? Call
Will you feel smart when you save thousands in an
Exchange with BlackAcre 1031? You sure will!!!
So call our Maryland or Virginia office now for your FREE 1031 Booklet and to set up your
ensure compliance with requirements imposed by the IRS, we inform you that, this communication (including any
attachments) does not contain anything that is intended as legal or tax advice, and that nothing herein can be
relied upon as legal or tax advice and further, the IRS wants us to let you know that nothing herein can be used
for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting,
marketing, or recommending to another party any tax-related matter addressed herein. If acting as your Qualified
Intermediary in a Section 1031 tax-deferred exchange, BlackAcre cannot advise the owner concerning specific tax
consequences or the advisability of a tax-deferred exchange for tax purposes. We recommend that anyone
contemplating an exchange seek the advice of an accountant and/or attorney.