4 Potential Pitfalls To A Successful 1031 Exchange

1031 exchanges can be complex, and one small oversight or misstep along the way can prove extremely costly, so it’s important that you recognize some of the common pitfalls and take steps to avoid them. However, many taxpayers aren’t fully aware of some of the most common roadblocks to a proper 1031 exchange, so it’s tough to avoid a problem that you don’t see coming. In today’s blog, we spotlight four potential roadblocks to a successful 1031 exchange so that you can keep your exchange on track.

Common Roadblocks To A Successful 1031 Exchange

Here are some of the more common issues that inexperienced taxpayers can run into during their 1031 exchange.

1. Exchanging Disqualified Properties - Not every property qualifies for a 1031 exchange. The properties must be like-kind and meet other eligibility requirements, like being property that is used for business, trade or investment purposes.

2. Exchanging Lower Value Properties - It is in your best interest to exchange equal or higher value properties and to replace any debt from the Relinquished Property with either new debt or cash in order to avoid a taxable event during the 1031 exchange.

3. Not Hiring A Qualified Intermediary - Not only is the process much easier if you move forward with a qualified intermediary, but it can also help you avoid an issue. A qualified intermediary keeps everything on track and ensures everything is conducted properly.

4. Choosing The Wrong Qualified Intermediary - It’s not enough to hire any qualified intermediary to handle your exchange. You need to work with a team with extensive experience and understanding of the IRC. The team at CPEC1031 has been facilitating 1031 exchanges all across the country for more than two decades, so there is hardly a situation that arises that we don’t have familiarity with. For a smooth and seamless exchange, it pays to read reviews and find a company that has helped a variety of clients manage their exchanges in the past.

For help avoiding all of these potential roadblocks, or if you are wondering if you qualify for a 1031 exchange, please reach out to the team at CPEC1031 today at (612) 643-1031.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

How to Use the 200% Identification Rule in a Reverse Exchange Under Revenue Procedure 2000-37

In a 1031 exchange, if you are parking the replacement property, the value of the identified relinquished properties cannot exceed 200% of the value of the replacement property.

Revenue Procedure 2000-37 states that:

• No later than 45 days after the transfer of the replacement property to the EAT, relinquished property must be identified in a manner consistent with the principles for identifying replacement property found in Treasury Regulation 1.1031(k)-1(c)(4).

The general consensus in the exchange industry is that an exchangor may identify more than one relinquished property, but the maximum number of relinquished property ties that a exchangor may identify is either three properties (determined without regard to the properties' fair market value) or any number of properties so long as the aggregate fair market value of the properties at the end of the identification period does not exceed 200 percent of the aggregate fair market value of the properties as of the date transferred. An exchangor may properly identify alternative and multiple properties.

In a typical forward exchange, identification is done in conformity with Section 1031(a)(3) that provides that replacement property received by the taxpayer is not treated as like-kind property if it:

• (a)  is not identified as property to be received in the exchange on or before the day that is 45 days after the date on which the taxpayer transfers the relinquished property (the “45-day identification period”); or

• (b) is received after the earlier of the date that is 180 days after the date on which the taxpayer transfers the relinquished property, or the due date (determined with regard to extensions) for the transferor's federal income tax return for the year in which the transfer of the relinquished property occurs.

Treasury Regulation 1.1031(k)-1(c)(4)(i) states that a taxpayer may identify more than one replacement property. Regardless of the number of relinquished properties transferred by the taxpayer as part of the same deferred exchange, the maximum number of replacement properties that the taxpayer may identify is:

• (A) Three properties without regard to the fair market values of the properties (the "3-property rule"), or

• (B) Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinguished properties as of the date the relinquished properties were transferred by the taxpayer (the "200-percent rule").

Further, Treasury Regulation 1.1031(k)-1(c)(4)(ii) states that:

If, as of the end of the identification period, the taxpayer has identified more properties as replacement properties than permitted by paragraph (c)(4)(i) of this section, the taxpayer is treated as if no replacement property had been identified. The preceding sentence will not apply, however, and an identification satisfying the requirements of paragraph (c)(4)(i) of this section will be considered made, with respect to:

• (A) Any replacement property received by the taxpayer before the end of the identification period, and

• (B) Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market vlaue of which is at least 95 percent of the aggregate fair market value of all identified replacement properties (the "95-percent rule").

For this purpose, the fair market value of each identified replacement property is determined as of the earlier of the date the property is received by the taxpayer or the last day of the exchange period.

Treasury Regulation 1.1031(k)-1(c)(4)(iii) states that for purposes of applying the 3-property rule, the 200-percent rule, and the 95-percent rule, all identifications of replacement property, other than identifications of replacement property that have been revoked in the manner provided in paragraph (c)(6) of this section, are taken into account.

For example, if, in a deferred exchange, B transfers property X with a fair market value of $100,000 to C and B receives like-kind property Y with a fair market value of $50,000 before the end of the identification period, under paragraph (c)(1) of this section, property Y is treated as identified by reason of being received before the end of the identification period. Thus, under paragraph (c)(4)(i) of this section, B may identify either two additional replacement properties of any fair market value or any number of additional replacement properties as long as the aggregate fair market value of the additional replacement properties does not exceed $150,000.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - How The Tax Reform Act of 2018 Impacted 1031 Exchanges

The tax reform act of 2018 modified 1031 exchanges severely and limited the scope of 1031s to just real estate. Prior to 2018, we were able to do 1031 exchanges of other business equipment such as fleet automobiles, airplanes, railcars, etc. However, Congress has made the decision to limit the scope of this tax deferral to only real estate.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - Tax Considerations when Selling Investment Real Estate

When you sell real estate, you may have a whole bunch of different tranches of tax. Investment property can be subject to NIIT (Net Investment Income) tax. Furthermore, if you depreciated the property while you were in ownership you may be subject to depreciated. If some of those components were rapidly depreciated you may have higher tax liability on that portion of the gain. Generally, depreciation is taxed at a higher rate than the preferred rates you get for normal capital gains. Certain accelerated depreciation can be taxed almost like ordinary earned income. Then you have routine capital gains on the appreciation that can occur over time. In some states and municipalities there can be local taxes applicable to your sale. It’s always a good idea to work with your local tax advisor who knows the nuances and practices in that particular area to get an illustration of what the fees and taxes will be at the state, federal and municipal level.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - Can You 1031 Exchange Real Estate Fixtures?

Prior to 2018’s tax code changes, we were able to do 1031 exchanges of non-real estate such as personal property (boats, airplanes, railroad cars, and the like). Today, 1031 exchanges are limited to real estate. However, there are certain fixtures that are incorporated into a building such as a water heater or specialty lighting that may still be eligible for rapid depreciation as if it were a separate component. Nonetheless, these items are treated as real estate fixtures for 1031 purposes.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved