1031 EXCHANGE HANDBOOK …
HOW DOES A 1031 EXCHANGE WORK?
The first requirement for a 1031 exchange is that both the property to be disposed of and the new property to be purchased be like-kind. This is one of the most misunderstood concepts in 1031 exchanges. Like-kind relates to the use of the properties. Any real property used for productive use in a trade or business or for investment qualifies as like-kind to other real property held either for productive use in a trade or business or for investment. You can dispose of a rental duplex to buy a strip mall. You can dispose of a warehouse and buy a condominium that you intend to hold for investment. In addition, raw land held for investment qualifies for 1031 treatment whether or not you had it leased.
Example 1:
Bill and Linda own a duplex they bought in 1986 and have rented it out ever since. They want to sell it and buy a condominium in Hawaii to rent out to others.
Does this qualify as a 1031 exchange? Yes, both properties are held for income or investment purposes.
Example 2:
Bill owns an office building that he leases to other doctors. Can he exchange the building for a piece of raw land on which to build an apartment building that he will hold for the rental income? Yes, investment property can always be exchanged for raw land held for income or investment purposes.
1031 EXCHANGE HANDBOOK …
THE 45 DAY IDENTIFICATION RULE
The Internal Revenue Code requires that you identify replacement properties within 45 days of the closing on the sale of the old property. The 45 days are calendar days so if the 45th day is Sunday, Christmas or the Fourth of July, that day is still the deadline for identification of new properties. No extensions are allowed. There are two ways to comply with the 45 day identification requirement. The first way is to have already purchased your new property. If you can use all your money from the sale (your exchange proceeds) your exchange is complete at that point.
In the event that you haven’t closed on a new property and spent all the money within 45 days, you must identify your new property. By midnight of the 45th day you must compile a list of properties that you are thinking about purchasing to replace the property you just sold. The list must be specific. It must be in writing. It must show the property address, the legal description, or other means of specific identification. It must be signed by the taxpayer. This identification list must be presented to a person who is involved in the exchange before the deadline.
You can identify up to three potential new properties without regard to the value of the properties on the list. If you wish to identify more than three potential replacements, the IRS requires that the total value of everything identified be less than double the value of the property or properties sold. This is called the two-hundred percent (200%) rule. You may identify more than three possible replacements, but be aware of the two-hundred percent (200%) rule. A third manner of identification exists, which is referred to as the 95% rule. In this rule, you can identify more than three potential replacement properties whose value is greater than twice the value of the relinquished properties, but if you do, you must acquire properties on the list whose value is at least 95% of the value of all of the properties on the list. Few people will attempt to qualify their transaction under the 95% rule.
If you wish to change the identification statement, you may do so until the expiration of the 45th day. After that date, it is not possible to change the identification. You must acquire at least one of the properties on the list that exists by day 45.
Example 1:
Jane sells her old property for $100,000 on January 1. She may identify up to three new properties of any value within 45 calendar days of January 1.
Example 2:
Jane sells her old property for $100,000.00. Jane wants to identify four potential new properties; four condominiums selling for $75,000 each. Is this okay? Answer, no, the four properties identified exceed two-hundred percent (200%) of the value of the property sold.
Posted in Real Estate Law | Tags: 1031 exchange, Hawaii Real Estate
