FAQ

Yes, if circumstances change and you decide to convert the use of a property acquired in a 1031 exchange into a principal residence, it can be done. Consult your tax adviser to ensure that the holding requirements of S1031 are met, and that you have otherwise complied with the S1031 safe harbor.

• Step 1 – Calculate the net adjusted basis.
  • Determine the original gross purchase price, plus closing costs.
    Add capital improvements during the period of ownership that were not expensed.
    Subtract any depreciation taken or allowed.
    That is the net adjusted basis.
• Step 2 – Calculate the net sales price.
  • Determine your gross sales price.
    Reduce it by the costs of the sale (e.g. brokerage commission, legal expenses).
    That is your net sales price.
• Step 3 – Determine the gain.
  • The gain is the net sales price less the net adjusted basis.

A property executed exchange permits the taxpayer to defer recognition of the gain on property held in productive use in business, trade or investment, beyond the date the gain was realized.

“Boot” is “other” property received by a taxpayer in an exchange. To successfully defer gains, no boot can be received. There are different types of boot.

Cash boot: This is the easiest to understand. Suppose the taxpayer sells the relinquished property for $1,000,000. The taxpayer decides to keep some of the proceeds for personal use, takes $100,000 of the proceeds and spends it on a car. That is, in its simplest form, “cash boot” and capital gains tax must be paid on this amount.

Debt reduction boot: Also known as “mortgage boot”, this occurs when the debt on the replacement property is less than the debt on the relinquished property. Let’s take an example. Taxpayer sells property for $1,000,000 which has a $500,000 remaining mortgage on it. The taxpayer buys a replacement property for $1,000,000, but finances only $300,000 on the replacement property. The taxpayer does this by adding cash of $200,000 to the transaction. In this example, the taxpayer “received” mortgage boot of $200,000 and “gave” cash boot of $200,000. So is that a wash?
The rules of netting boot: Stay with me here, because this is where we start to get a little advanced. The rules of netting boot are as follows: (1) cash boot paid offsets cash boot received at the same closing table, (2) cash boot paid offsets mortgage boot received, (3) mortgage boot paid offsets mortgage boot received, BUT (4) mortgage boot paid does not offset cash boot received. Huh?

Let’s take each rule by itself.

1. Cash boot paid offsets cash boot received: Bob puts down $100,000 as a contract deposit for the replacement property from his own funds. At closing, the proceeds from his relinquished property are used to acquire the replacement property, and as a result he gets back $100,000 at closing. That is cash boot. But the boot received is offset by the boot paid (the $100,000 he put down) so these net out.
2. Cash boot paid offsets mortgage boot received: Bob sells his property for $1,000,000, which had $500,000 in mortgage owed. He buys a replacement property for $1,000,000, but pays all cash for this property. He has “received” $500,000 in mortgage boot, and “paid” $500,000 in cash boot, so these two can be netted.
3. Mortgage boot paid offsets mortgage boot received: Bob sells his property for $1,000,000 which had $500,000 in mortgage owed. He buys a replacement property for $1,000,000, but finances only $300,000 with a new loan. However he assumes the seller’s loan of $200,000 remaining on the property. In this case he paid $200,000 in mortgage boot by assuming the loan, and received $200,000 in mortgage boot by reducing the balance on his mortgage, so these will net each other.
4. Mortgage boot paid does not offset cash boot received: Bob sells his property for $1,000,000 which had $500,000 in mortgage owed. He buys a replacement property for $1,000,000, but finances $700,000 in a new loan and receives at closing $200,000 back from the intermediary. Bob “paid” $200,000 in mortgage boot because his loan increased, and “received” $200,000 in cash boot because he got cash back at closing, but these cannot be offset against each other and he will be liable for tax on the cash boot.

This is property held for productive use in business, trade or investment which is sold, and the proceeds of the sale are assigned to a QIto hold until the replacement property is acquired.

The IRSrequires the replacement property to be “like kind” of the relinquished property. Only real estate can be exchanged, and “like kind” means that if you sell a domestic commercial property (e.g. within the US) then you must also acquire a domestic commercial property.

No, direct deeding is permitted under IRSrules.

No, the regulations are strict, no extensions can be granted unless a ruling is made by the IRS.

Partial exchanges are allowed, but tax must be paid on the net boot realized.

The taxpayer must intend to use the replacement property for productive use in business, trade or investment. Most tax advisers urge the property to be held at least one, and sometimes two, years.

Check with your local tax adviser, but generally yes.

Under the IRCa QIis an independent party who facilitates the exchange. The QI cannot be the taxpayer or a disqualified person. Disqualified persons are those who have a relationship: Attorney, CPA, or banker who represented the taxpayer within 2 years prior to closing of relinquished property, other than with respect to representing them on the closing of the relinquished property.

The QI holds the proceeds to prevent the taxpayer from having actual or constructive receipt of the funds.

No, that will taint the exchange and disqualify you. The regulations are generous, but strict. Taxpayer may not receive the proceeds or take constructive receipt in any way.

No, as long as title has not transferred, the exchange can be done successfully.

Yes, once the taxpayer gets real or constructive control over the funds, the exchange is tainted and will not work.

No, direct deeding is permitted.

There are two major deadlines:

Within 45 days of closing, identify replacement property in a writing to the QIsigned by the taxpayer. There are 3 rules for identifying the replacement properties.

• Taxpayer can identify 3 like kind without regard to value.
• Any number can be identified, but total value cannot exceed twice the value of relinquished.
• Identify any number, but before the end of the exchange acquire replacement properties with an aggregate fair market value of at least 95% of the fair market value of all the identified.

And within 180 days of the sale of the relinquished (or the filing of the tax return for the tax year in which the relinquish closed, whichever occurs first) the replacement property must be purchased. No extensions can be granted.