Here, you will find definitions of terms and phrases frequently used in the world of 1031 Exchanges.
A 1031 Tax Deferral permits taxpayers to reinvest the proceeds from the sale of property held for investment or business purposes into another investment or business property, and defer capital gains tax that would otherwise be due on the initial sale.
The original basis plus improvement costs minus the depreciation of the property.
Agreement for Transfer
Purchase agreement, sale agreement, earnest money agreement, offer & acceptance, real estate contract or other contract contemplating the purchase or sale of real property.
Property the taxpayer receives in the exchange which does not qualify as “like-kind property”. Cash proceeds are the most common form of boot. Boot is subject to taxation.
Capital gain is calculated as follows: total selling price of the relinquished property, less exchange expenses, less the relinquished property’s adjusted basis. The adjusted basis is the original cost, plus the cost of capital improvements, less depreciation or cost recovery deductions. Capital gains may be subject to depreciation recapture and other rules of the internal revenue service.
You may purchase replacement property that is not yet built, provided that the improvements on the property are completed prior to the expiration of the 180 days. In a Construction Exchange, the property is held by a specially formed LLC called the EAT (Exchange Accommodation Taxpayer). A Construction Exchange generally has greater complexity and fees than a 1031 Exchange.
A term that refers to the exchanger having unrestricted control of the equity from the property sold. A Constructive Receipt will invalidate a tax deferred exchange.
A Contract Exchange is the tax-deferred exchange of: The Buyer’s ownership in a Sales Contract on real property, for different real property, or for a contract or option on different real property; or the Option Holder’s exchange of an Option to purchase real property, for different real property, or for an option or contract on different real property. Essentially, a contract exchange is an exchange of an open option to purchase, or an open Sales Contract, rather than an exchange of the underlying real estate itself.
Clause added to the purchase on sales agreement requiring the person who is not the exchanger to use their best efforts to assist the exchanger in consummating a 1031 tax deferred exchange.
The owner of the investment property looking to make a tax deferred exchange. Unfortunately an exchanger cannot be an owner that wishes to defer capital gains tax on a “second home”. See like-kind property definition.
Exchange Funds Account
The account established by the qualified intermediary to hold the exchange funds.
The 180-day window in which the exchanger has to complete a tax deferred exchange. During the exchange period there is a 45-day identification period in which the exchanger must identify which property or properties will be purchased.
Fair Market Value
The likely selling price as defined by the market at a specific point in time.
Forward Delayed Exchange
A type of exchange which occurs when a property is sold (Relinquished Property) and another property is purchased (Replacement Property) within 180 days following the sale of the Relinquished Property.
The time period that begins upon the close-of-escrow of the relinquished property. During this 45-day period, the exchanger must identify the replacement property in order to continue with the section 1031 exchange transaction.
An Identification Removal form is used to remove previously identified Replacement Property(ies) within the Identification Period of 45 days.
An Identification Statement form is used to identify potential replacement property(ies).
Internal revenue code section 1031.
The properties involved in a tax deferred exchange must be similar in nature or characteristics. Like-kind real estate property is basically any real estate that isn’t your personal residence or a second home.
You must buy a Replacement Property of equal or greater value to the Relinquished Property in order to completely defer the applicable capital gains tax. If you purchase a property of lesser value, you will be responsible for any tax on the difference. You must also use all the cash proceeds from the sale on your purchase in order to completely defer the applicable capital gains tax. If you do not use all your proceeds on the purchase, you will be responsible for any tax on the difference.
The purchase price of a property. It is used to calculate capital gains or losses for tax purposes.
Any property belonging to the exchanger that is non-real estate related.
The process in which the relinquished property is sold and all respective paper work for that process is completed. This process is also known as the “down-leg” of the tax deferred exchange process.
The process in which the replacement property is bought and all the respective paperwork for that process is completed. This process is also known as the “up-leg” of the tax deferred exchange process.
Intermediary, QI, accommodator, facilitator, qualified escrow holder. A third party that helps to facilitate the exchange.
Real Estate Exchange
Exchange of real property for real property. All types of real property are like-kind for other real property, including vacant land, residential, commercial, and even long term leases.
The original property being sold by the taxpayer when making an exchange.
The new property being acquired by the taxpayer when making an exchange.
Type of exchange in which the Replacement Property is purchased before the sale of the Relinquished Property.
Tax Deferred Exchange
The procedure outlined under Internal Revenue Code Section 1031 involving a series of rules and regulations that must be met in order to take full advantage of deferring capital gains tax on the sale of investment real estate. §1031 tax-deferred exchanges are also commonly known as: Starker exchanges, delayed exchanges, like-kind exchanges, 1031 exchanges, section 1031 exchanges, tax-free exchanges, nontaxable exchanges, real estate exchanges, real property exchanges. Though all of these terms refer to the same thing, the most typical term used today is tax deferred exchange.
Tenancy In Common (TIC)
A fractional ownership interest in a piece of property, rather than owning the entire piece of property.
Three Property Rule
The Exchanger may identify up to three properties, without regard to their value.
200% Percent Rule
The Exchanger may identify more than three properties, provided their combined fair market value does not exceed 200% of value of the Relinquished Property.
95% Percent Rule
The Exchanger may identify any number of properties, without regard to their value, provided the Exchanger acquires 95% of the fair market value of the properties identified.