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A Brief Explanation of the Reverse 1031 Exchange

Reverse 1031 Exchange

1031 exchanges come in several different forms. There are real estate exchanges, personal property exchanges, build-to-suit exchanges, and more. In this article, we are going to offer a brief overview of the reverse 1031 exchange and how it can be used as a vehicle for tax deferral when selling real estate.

The Reverse Like-Kind Exchange

A reverse 1031 exchange is a like-kind exchange in which the taxpayer acquires their replacement property first, before selling their relinquished property. This is essentially the reverse of the standard order or operations. Reverse exchanges are often utilized in competitive real estate markets, where you might need to lock down a property before someone else does.

Reverse Exchange Guidelines

There are many guidelines that you have to be aware of when doing a reverse like-kind exchange. Here are a few of the most important rules:

  • 180 Day Time Period. In any 1031 exchange you only have 180 days total to complete your exchange. If your exchange is not complete within this time period, it will fail.
  • Like-Kind Requirement. All property involved in the exchange must be like-kind.
  • Held For Requirement. You must also hold your property for business or investment purposes. You cannot 1031 exchange property held primarily for your own personal use.
  • Value, Equity, Debt. Your replacement property has to be equal to or greater than your relinquished property in terms of value, equity, and debt.

Minnesota 1031 Exchange Professionals

At Commercial Partners Title, we work with investors and taxpayers across the country on all sorts of real estate transactions. We work directly with CPEC1031 (Commercial Partners Exchange Company) to facilitate 1031 exchanges when necessary. With decades of experience, we are recognized as experts in commercial transactions. If you are interested in learning more about the tax benefits of a 1031 exchange, contact us today!

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The Requirements of a 1031 Exchange

 

1031 Exchange Requirements

There are a lot of rules and requirements that govern the exchange of like-kind property. In this article, we are going to explain the most important requirements for any successful 1031 exchange.

You Need to Hold Your Property for the Requisite Use

In order to qualify for a 1031 exchange, you need to be of the right mindset when it comes to holding your property. In a nutshell, you need to hold your property for investment or business use. Personal use property is not allowed in a 1031 exchange.

Your Property Needs to be Like-Kind

All of your property involved in the 1031 exchange needs to be of “like-kind” to one another. What does “like-kind” mean? When you’re dealing with real estate, “like-kind” is defined very broadly, in that most real estate is considered like-kind to most other real estate. You can exchange an apartment building for a hotel, or for a piece of farmland. That broad definition gets a lot narrower when you are looking at an exchange of personal property. Personal property needs to be in the same general asset class in order to be considered like-kind. So you can exchange a painting for another painting, but not for an airplane (as the two would not be considered like-kind).

You Need to Complete Your Exchange Within 180 Days

The IRS has very strict timelines for completing a 1031 exchange. You have a total of 180 days to finish your exchange. That clock starts ticking after the sale of your relinquished property. If you fail to exchange into your replacement property before midnight on the 180th day, your exchange will fail. In addition, you have to identify in writing your replacement property during the first 45 days of that 180 day period.

You Need to Go Up in your Value, Equity, and Debt

You also need to make sure that you are exchanging into a replacement property that has more value, equity, and debt than your relinquished property.

These rules and requirements can be difficult to keep track of, If you have any questions about whether or not you’re abiding by all the necessary 1031 requirements, contact Commercial Partners Exchange Company to discuss your exchange.

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Key Information You Need to Begin a 1031 Exchange

Start a 1031 Exchange

When you’re starting a 1031 exchange the qualified intermediary needs to jump into the transaction and get to know all the key details really quickly. This might be a transaction that you’ve been negotiating and working on for months or even years, and a qualified intermediary needs to become familiar with these details quickly.

So, here’s what the qualified intermediary needs to get their arms around all of these details and begin the 1031 exchange.

Information on the Seller

First we’re going to need information on the seller. The seller’s address, contact information, and EIN (federal employer identification number) or social security number as the case may be. So we need to know who the seller is and their pertinent information.

Purchase Agreement and Sale Contract

Next we need to get a full copy of the purchase agreement or sale contract for the sale of the relinquished property and any amendments or addendum to that agreement so that we know who the parties are and what the property is.

In addition to that we need to be able to determine exactly how the seller is vested in title and what the legal description of the property is. How do we find that out? Oftentimes the buyer will have the title company prepare a title commitment or an attorney’s opinion of title or other title report that the intermediary can you use to verify the legal description and the vesting of how the seller is entitled. It’s important to know who’s entitled because that party or parties that are listed are those that need to do the exchange.

Married Taxpayers

If a taxpayer is married their spouse may or may not be on title. If the taxpayer is elderly they may have the property in a trust or they may own it in their own individual name, or they may have placed it into some kind of business entity.

All of these details need to be determined quickly and accurately by the intermediary so that we can prepare the 1031 documents for circulation and review to the taxpayer’s attorney, accountant, and any other professionals involved in the transaction to make sure that the exchange documents correlate with the details and specifications of the transaction.

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1031 Exchange Tips for Title Closers

1031 Exchange Title Closers

Title closers deal with settlement statements day in and day out, but there are additional precautions required when the closing involves a 1031 exchange. There are three essential items that title closers need to be cognizant of so the 1031 exchange goes off without a hitch – taxes, security deposits, and rent prorations. In this article, we’ll discuss how title closers should handle each of these items on the settlement statement to avoid any issues with a 1031 exchange. Our primary goal when the seller of a property is doing a 1031 exchange, is to roll all of the net-sales proceeds over into the 1031 escrow account so that they can be re-invested into like-kind replacement property. Not all transactional costs and fees should be paid for from the sale proceeds on the closing statement.

Taxes

The seller of the relinquished property needs to pay the real estate taxes owed for the time period that they owned the property during the year. When there’s no 1031 exchange involved, the seller typically pays these taxes out of their sale proceeds on the closing statement. But when the seller is conducting a 1031 exchange, we need to keep these payments separate from the sales proceeds. In an ideal world, the seller would pay their prorated real estate taxes in out-of-pocket cash at the closing. This can avoid a big headache later on in the exchange.

Security Deposits

If the closing involves a property that has been or is currently being rented out to tenants, we also have to be careful about security deposits. The seller of the property should be holding all security deposits for their tenants in a bank account separate from their operating account. If that’s the case, then the seller can simply take the money out of that separate account and pay the security deposits over to the buyer at the time of closing. However, if the seller has been keeping these deposits in their general operating account and the seller is feeling cash-poor, things get more complicated. If this is the case, it’s time to talk to a 1031 professional to determine the best way to proceed so you don’t jeopardize the exchange.  Ideally, the seller will come up with the money to transfer the security deposits over to the buyer out-of-pocket rather than dipping into the sales proceeds (which could diminish the value of the 1031 exchange).

Rent Prorations

At closing, the seller should also pay the buyer the portion of the rents they have collected for the month. Since the seller has likely already collected the rents for the month and deposited them into their operating account, it’s best to have the seller wire this money out of their operating account and pay it out of pocket at closing to the buyer.  This is the preferred way to handle rents, as opposed to dipping into the sales proceeds (which could diminish the value of the 1031 exchange).

The Big Picture

The big picture when closing a 1031 property is that you want to move all of the equity (the net proceeds) over to the qualified intermediary. If you’re ever in doubt, it’s always best practice to have the seller pay closing expenses out of pocket at closing.

  • 1031 Hotline: If you have questions about 1031 exchanges and title closings, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

 

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Phone: 612.337.2470
Fax: 612.337.2471
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Minneapolis, MN 55402

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Commercial Partners Title provides commercial title services throughout the state of Minnesota and the United States, including: Minneapolis, Rochester, St. Cloud, St. Paul, Bemidji, Bloomington, Golden Valley, Duluth, Edina, Minnetonka, Plymouth, Chaska, Mankato, Fargo, Sioux Falls, Madison, Milwaukee, Miami, North Dakota, South Dakota, Florida, Iowa, and more!

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