A Guide to 1031 Exchanges in Jacksonville

March 15, 2022

1031 Exchange gets its name from the Internal Revenue Code (IRC) Section 1031. In brief, it’s a swap of one investment property for another, allowing an investor to defer payment of capital gains taxes.

As a real estate investor, you may be able to exchange, for instance, raw land for an office building, a warehouse for a NNN retail property, or a rental house for a multi-unit apartment complex.

As an investor in Jacksonville, you should especially consider doing a 301 Exchange if:

• You’re looking for a better asset in a more desirable market
• You want higher tax-deductible expenses
• Want to leverage tax benefits of greater depreciation

With that in mind, for an exchange to be successful under Section 1031 of IRC, there are certain requirements that you must meet. The following is a guide to 1031 Exchanges in Jacksonville.

Requirement #1: The Properties You’re Exchanging Must Be “Like-Kind”

Section 1031 of the IRC requires that the properties getting exchanged be of the same kind. In property law, like-kind properties are those that share the same nature or character, even if they differ in regards to quality or grade.

Generally, real properties are like-kind, regardless of whether they are improved or not. But the properties must be held for business or investment purposes.

Exchanging raw land for a multi-unit rental complex, for instance, would qualify. So would exchanging a single-family rental for an apartment.

On the other hand, a certificate of trust, trade inventory, partnership interests, as well as stocks wouldn’t qualify for a 1031 Exchange.

Requirement #2: The Exchange Must Be Done By a Qualified Intermediary

A Qualified Intermediary is also known as a 1031 Exchange Accommodator. The QI is an independent person, company, or entity that facilitates the transfer of proceeds in a 1031 Exchange. They are the glue that puts the buyer and seller of property together into the form of a 1031 Exchange.

The QI can be anyone except for your agent (such as a real estate broker, agent, CPA, or attorney).

During the exchange, the QI has three important responsibilities:

• Hold the sale proceeds of the relinquished property in an escrow account, as the exchanger is barred from taking possession of the funds throughout the exchange process
• Complete the documentation relating to the identification of the replacement property within the required timeline
• Facilitate the replacement property’s purchase by transferring the exchanger’s funds to the seller/title company

Requirement #3: The Value of the Replacement Property Must Exceed That of the Relinquished Property

Basically, the new property (replacement property) must have greater value than the one you have currently (relinquished property).

For example, suppose you’re selling your property for $300,000 with sales costs amounting to $10,000. As such, the replacement property must have a value greater than $290,000. Brokerage fees, attorney fees, and escrow are examples of some sales costs.

Requirement #4: Non-Like-Kind Property Attracts Capital Gains Tax

Non-like-kind property received in an exchange is referred to as “boot.” Boot is usually in the form of personal property, debt relief, an instalment note, or cash and is valued to be the “fair market value” of the non-like-kind property received.

For example, if you sell a property for $200,000 but only re-invest $170,000, the $30K difference would be boot.

The goal of Section 1031 of the IRS is to incentivize taxpayers when it comes to widening their investment portfolios. As such, acquiring a replacement property that is of less value than the relinquished property and pocketing cash proceeds from the sale would defeat its purpose.

But does boot disqualify a 1031 Exchange? Not at all. As long as the exchange has met all other requirements, only the boot would be liable to capital gains tax. Normally, IRS subjects boot to the most expensive Federal tax rate.

Requirement #5: You Must Adhere to the Timelines

There are strict timelines that investors must adhere to when carrying out a 1031 Exchange. The first timeline is the 45-Day identification window. Once you have sold the property, you’ll effectively be under the 45-day deadline to identify a replacement property.

This 45-day window is known as the “identification period.” The period starts counting the moment you close on the relinquished property. You can identify three replacement properties or more, as long as their aggregate fair market value doesn’t exceed 200% of the aggregate fair market value of the relinquished property.

The other timeline you must adhere to is the 180-day rule. It basically states that the transaction must be completed in 6 months or no more than 180 days. So, once you have identified the property, you’ll have an additional 135 days (45+135=180) to close on the replacement property.

Almost exclusively, no extensions are granted for the aforementioned dates. The only exception is when a federally declared disaster impacts either you, the qualified accommodator, or the CPA. Other than those, the clock will keep ticking regardless of whether those days fall on a holiday or a weekend.

Types of 1031 Exchanges

There are four main types of like-kind exchanges that you can choose to execute. They are as follows:

• Delayed 1031 Exchange. This is the most common type of exchange that investors use today. This requires the exchanger to relinquish their property first before acquiring the replacement property, as explained above
• Reverse Exchange. This is the opposite of a Delayed 1031 Exchange. This requires an investor to acquire the replacement property prior to selling their existing property. Buy first, exchange later
• Improvement Exchange. This allows an investor to use tax-deferred dollars to make improvements on the replacement property
• Simultaneous Exchange. This is when the replacement property and the relinquished property close the sale on the same day, making the exchange simultaneous

Bottom Line

A 1031 Exchange can help you buy more profitable properties, diversify your investment portfolio, or defer taxes associated with depreciation. One caveat, though: it must be done correctly. If you’re just getting started, Innovative Property Solutions can be an invaluable partner. Get in touch today to learn more!