Dos and Don’ts of a 1031 Exchange

Dos

Do make sure that a Section 1031 exchange is right for your tax situation and investment goals.

Do plan in advance.  Talk to your accountant, tax advisor, attorney, and real estate broker well in advance of beginning a Section 1031 exchange.

Do assemble your team of strategic partners in advance, including a qualified intermediary, an experienced and investment oriented real estate broker, and a tax advisor.  Perform due diligence in selecting an experienced and reputable qualified intermediary.  Make sure that your qualified intermediary is properly bonded and insured. 

Do get your books and past tax returns in order so that you know the adjusted basis on your relinquished property.

Do advise the buyer of your relinquished that you will be performing a Section 1031 exchange and contractually obligate them to cooperate in the exchange process.

Do perform due diligence on your replacement property — obtain a full title policy, historical cash flow, tax returns, leases, contracts, property conditions report, toxic waste analysis, demographics report, appraisal, tenant credit checks, and tenant estoppels.

Do know the basis of your replacement property. 

Do trade up, not down. 

Do avoid receiving “boot.”  In particular, make sure that any debt on the replacement property is equal to, or greater than, the debt on the relinquished property.

Do make sure that both the property you are relinquishing and the replacement property have been held for productive use in a trade or business or for investment.

Do make sure that the title to the replacement property will be held in the same manner as the your title on the relinquished property.

Don’ts

Don’t engage in a Section 1031 exchange without thorough planning well in advance of the exchange.

Don’t go it alone.  Before you embark on a Section 1031 exchange, put together your team of strategic partners, including an experienced, bonded, and insured qualified intermediary, an experienced and networked investment oriented real estate broker, and a tax advisor.

Don’t ignore or forget about the strict time limitations of 45 days for identification and 180 days to complete the exchange.

Don’t assume that you can do a Section 1031 exchange on property that is your personal residence.  You can’t.  But with proper advance planning, you can recharacterize a personal residence as an investment property and then exchange it under Section 1031.  If you have questions about whether your property could be considered your personal residence by the IRS, or if you want to recharacterize your personal residence and then do a Section 1031 exchange, make sure that you consult with your legal and tax advisors well before you attempt to initiate a Section 1031 exchange.

Don’t try to do an exchange on a property after you have sold it.  You cannot exchange property after you have sold it.  While this may seem too obvious to mention, many people make this mistake.  Real estate professionals are constantly hearing from people who say “I sold my property last month and I want to do a 1031 exchange.”  Don’t be one of them.  And remember, any receipt or legal control of the proceeds from the transfer of your relinquished property before you have obtained the replacement property will immediately turn the transaction into a taxable sale.

From 1031 Exchanges Made Simple, available at Amazon.com. 

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com

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