There are still so many people, including far too many tax and real estate professionals, who are unclear on how Section 1031 like kind tax deferred exchanges work. One common misconception is that the exchange can only be one for one; dispose of one property and replace it with a single property costing at least as much as the original property's net price. That has never been true, and has actually been a very unwise move when working with very expensive properties. Diversifying by replacing one expensive property with several of lower value is a great way to avoid the classic investing mistake of putting all of one's eggs in a single basket.
Another common misconception is that the replacement property has to be in the same state as the original. While there are a very few states that may tax exchanges that move equity beyond their borders, that is not true for the IRS.
Please refer to the following summary of exchange regulations for some basic rules.
SUMMARY OF EXCHANGE REGULATIONS
TIME DEADLINES:
Identify replacement property and notify Accommodator within 45 calendar days from disposition of old property
180 calendar days, beginning at same time as 45 day period, to complete entire exchange.
PROPERTY IDENTIFICATION:
3-Property Rule: Up to three properties may be identified without regard to their fair market values .
200% Rule: If more than three properties are identified, their combined fair market values cannot exceed twice the fair market value of the property being disposed of.
95% Rule: Permits identification of any number of properties if 95% of the aggregate value of the named properties is acquired within the exchange period.
Identified properties may be changed, in writing, within the 45 day identification period.
CONSTRUCTION:
New construction may qualify if properly identified. Any costs incurred after the 180 exchange period will not count as reinvestment of exchange proceeds.
LIKE KIND PROPERTY:
IRC Section 1031 requires exchange of "like-kind" properties. This refers to the nature, character or class of property. It does not require the exact same grade, quality or use of the properties. Real property for real property is like kind. Personal property may be exchanged within stricter guidelines.
ACCOMMODATOR/FACILITATOR:
An unrelated third-party facilitator or accommodator must be used to acquire the exchanger's property and transfer replacement property to the exchanger. IRS regulations allow direct deeding of the replacement property to the exchanger.
REVERSE EXCHANGES - See this FAQ
??Caution: There are many more nuances and twists to tax deferred exchanges than can be presented here. Before beginning any real estate transaction, you should consult with a qualified tax professional. All aspects of your unique tax situation need to be evaluated. There are times when a tax deferred exchange is not the best approach.
