Q: What must I do in order to defer paying all capital gains taxes?

A: In order for an investor to defer all capital gains taxes, there are four general guidelines that must be followed:

  1. The Replacement Property must be equal to or greater in value
  2. The debt on the Replacement Property must be equal to or greater in value
  3. The equity in the Replacement Property must be equal to or greater in value
  4. All net proceeds must be used to acquire Replacement Property 

To the extent that the value, debt or equity on the Replacement Property is less than the value, debt or equity on the Relinquished Property, the Exchanger may have taxable boot. 

Q: Are there time limitations to complete an exchange?

A: An Exchanger must identify the Replacement Property within 45 days after the sale of the Relinquished Property and close on the Replacement Property within 180 days after the close of the Relinquished Property. 

Q: Can I buy a Replacement Property before I sell my Relinquished Property?

A: This is known as "reverse exchange." In September of year 2000, the IRS issued Revenue Procedure 2000-37 which is a "safe harbor" for completing 1031 reverse exchanges. Although somewhat more complicated, with careful structuring and planning, reverse exchanges (and constructions and improvement exchanges) can be a viable option. 

Q: How are transactional costs handled?

A: Some transactional costs paid by the Exchangers reduce realized and recognized gain and increase the tax basis of the Replacement Property. For instance, if the Exchanger receives $15,000 cash back in the exchange but has $10,000 in other exchange expenses, the Exchanger will recognize only $5,000 taxable income and $10,000 will be added to the tax basis of the Replacement Property. Practitioners suggest that other transactional costs may also be deducted if paid in connection with the exchange. These costs typically include commissions, transfer taxes, finder's fees, title insurance premiums, legal fees, intermediary fees, and recording fees. 

Q: Where are the sale proceeds held?

A: The sale proceeds are held in a federally insured account with local banks and are held in the name of Greater Boston Exchange Company, LLC.

Q: In what tax year is the exchange reported?

A: The Exchanger must file Form 8824 for each tax year property was transferred to another party in an exchange. In addition, Form 4797 must be filed for depreciable property and Schedule D for non-depreciable property in the year the Relinquished Property is sold. 

  • Defer paying capital gains taxes
  • Exchange several smaller, hard to manage properties for one larger, easier to manage property.
  • Exchange a partial interest in one property to a full interest in another property.
  • Exchange to a property an investor may use in his own practice (e.g. a doctor could sell a rental property and buy an office building he may use for his practice).
  • Exchange raw land for rental property to generate cash flow.
  • Exchange depreciated property to higher value property that can be depreciated.
  • Exchange a rental property in Boston for a rental property in Florida, which might be allowed to serve as a retirement home. 

motives for exchanging

  • Exchanger​ - if the taxpayer who is electing to defer the capital gains by effecting a 1031 exchange. 
  • Buyer - is the person who is purchasing the property the Exchanger is selling.
  • Seller - is the person who owns the property the Exchanger is buying.
  • Qualified Intermediary (QI) - is a neutral party (it may be an individual or an entity and it can not be the Exchanger's accountant or attorney) who facilitates the exchange by holding the proceeds from the sale of the Relinquished Property and then using such proceeds for the purchase of the Replacement Property. The QI also provides all the proper documentation to preserve the integrity of the exchange in case of an audit. 
  • Relinquished Property - is the property the Exchanger is selling in the exchange. 
  • Replacement Property - is the property the Exchanger is buying in the exchange. 
  • Boot​ - is any non-like kind property received in the exchange (e.g. cash, debt relief). Boot is taxable. 

Basic terminology of 1031 exchanges