1031 exchange process, timelines and examples. There are a number of ways to successfully complete, or complicate, a 1031 exchange.
A few weeks ago, we wrote about like-kind exchanges (also known as an Internal Revenue Code Section 1031 exchange) and the temporary relief being granted to some buyers and sellers during the COVID-19 pandemic.
For those of you who missed the column, a like-kind exchange is where an owner of an investment piece of property decides to sell it, use a qualified intermediary and then buy a replacement property within a relatively short period of time. For their effort in using the 1031 mechanisms, the owners of the sold property are allowed to defer paying federal income and recapture taxes to the IRS. There are strict timing restrictions and other rules you must abide by, and you should talk to a person that specializes in 1031 exchanges to make sure it would be helpful to you financially.
1031 Exchange Process, Timelines and Examples
After the column was published, we heard from a number of readers. Here is an edited sample of their comments and questions:
Just wanted to drop you a note in case you write another article on 1031 exchanges. When selling a jointly-owned property, say a limited liability company (LLC) where each member is a 50 percent owner in the LLC, both members must agree and participate in the sale of the property and use the 1031 exchange together. They must both sell and then must both buy a replacement property using the 1031 mechanism.
Often though, two partners have different views on what to do with the sale and what to do with the proceeds from the sale. One may want to continue in real estate and the other may want to liquidate and start making estate planning arrangements. However, If the LLC is disbanded, broken up into two separate partnerships roughly 9 to 12 months before a sale, then each partner can use a 1031 exchange, if they wish, or take the cash, pay their taxes and make the grandchildren happy.
You’re right on this one. When a property is owned in a corporation, limited liability company (LLC) or other entity, the selling entity must contemplate the sale, the use of a 1031 exchange and intermediary and the purchase of a replacement property. For a 1031 exchange to work, the seller of the old property must be the same as the buyer of the replacement property. In this particular example, the owner of the old property was the LLC and not the LLC’s members. So if the LLC wants to sell the property, it can and it can then buy a replacement property.
In many situations, partners and co-owners have differing views of what the future holds. And, as you stated, if you plan ahead, the partners, owners or members can change the ownership structure well before the sale to allow one of the owners to continue on with real estate ownership while the others do something different. Again, planning well in advance and working with a 1031 exchange specialist a year or two before a sale will go a long way to helping all of the owners with their needs and desires.
Remember, when it comes to 1031 exchanges, the owner of the current property must be the owner of the new replacement property. So, if a company owns a piece of property, sells it and opens up a 1031 exchange, the replacement property must be purchased by that same company. There are certain exceptions, but you need to work closely with your intermediary to make sure that the exception applies to your transaction.
Saw your article about 1031 exchanges in Sunday’s real estate section of our paper. Did you overlook the elephant in the room? The questioner said he recently sold a condo. If he sold and collected the proceeds, wouldn’t that eliminate the possibility of a 1031 exchange as it requires a qualified intermediary to help in the exchange process? That point should have been clarified before the rest of the answer, or at least mentioned in the article.
The question stated that (s)he had “recently sold a condo…”. Most people don’t differentiate between “sold” and “closed,” and I read it to mean that the condo sale was complete.
Yes, if the seller had signed a contract and had not closed on the sale, the seller still has the ability to complete a 1031 exchange. However, as you rightly noted, if you have closed on the sale of the property and have the cash from the sale in hand, you’re out of luck and can’t then try to start a like-kind exchange.
I saw your column on 1031 exchange rules and limitations in my local newspaper on like-kind exchanges. Can you use a 4-unit rental property as an item that would be exchanged with a large “REIT” on the stock exchange?
There are some ways of investing in real estate investment trusts (REIT), but not the way you might think. These investments generally involve Delaware Statutory Trusts and probably are not the REITs you’re looking at in a newspaper or stock exchange.
It’s too complicated to go into the details of the process here but you can place a call to some of the larger national companies that act as 1031 exchange intermediaries and they can walk you through the process.
If you’re looking to exchange your 4-unit rental property for a real estate investment that requires you to be less involved with the day-to-day management of the investment, you can buy into a property (or group of properties) that are managed by a TIC, which stands for Tenant in Common.
Here’s how they work: A company that specializes in TICs will sell you a fraction of an investment in a project, development or building where you will own a percentage but not the whole thing. The TIC takes care of the project, development or building and they take care of everything you need (and you’ll get whatever revenue is generated after payment of management and other fees) and you will be an owner alongside other owners.
It’s a less active real estate investment but it should work for a 1031 exchange. Just be aware you’re not anonymous because you actually own a piece of the underlying real estate in the TIC. With a Delaware Statutory Trust, you wouldn’t own the real estate but instead would be the beneficiary of a trust that owns the real estate.
Both TICs and Delaware Statutory Trusts are more complicated legal instruments and you should work with a knowledgeable attorney and accountant who can help you understand the details and how they’ll affect your finances.
Finally, keep in mind that you can’t sell your ownership in real estate and exchange that for stock in a company or a membership interest in a limited liability company.
More on Topics Related to the 1031 Exchange Process
1031 Exchange Rules and Limitations
How To Avoid Taxes When Selling A Rental Property With A 1031 Exchange
Will a 1031 Exchange Help Avoid Capital Gains Tax on an Inherited Home?
How Long Do You Need to Keep a Property Purchased with a 1031 Exchange?
How to Sell Your 1031 Exchange Inheritance
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