How to do a 1031 Exchange in Florida
While it’s not the most common type of real estate transaction we handle here in Southwest Florida, in the past year or two, our office has seen an increase in inquires regarding the 1031 Exchange. Having managed a few different “Starker Exchanges” as they are also referred to as we thought you might find the following information useful in learning more about the 1031 Exchange, and how it works.
What’s with the name?
The 1031 “Like-Kind” Exchange stems from Section 1031 of the IRS Code. “Starker Exchange” refers to the name of the first tax case that allowed a “delayed exchange” to take place, where you no longer had to swap properties but could sell your property first and have 180 days to find a suitable replacement property.
What is a 1031 Exchange?
Under Section 1031 of the United States Internal Revenue Code, a taxpayer may defer recognition of capital gains, depreciation recapture, and related Federal income tax liability on the exchange of certain types of property.
Basically, an investor can defer the payment of capital gains taxes on the sale of an investment property, if a like-kind property is purchased with the proceeds from the sale of the first property. Now there are obviously a set of rules and regulations that accompany this section of the code. But, it’s important to note right off the bat that a 1031 Exchange only applies to investment or business property, not personal property.
Let’s dive deeper…
Four Important Guidelines for a 1031 Exchange
1.) In order to defer 100% of the capital gains tax, the purchase price and any unpaid loan amount from the relinquished property (the current investment you wish to sell) must be the same or greater for the replacement property (the new property you wish to buy). For example, if your relinquished investment sells for $500k, your replacement property(s) must also amount to $500k in order to defer 100% of the tax.
Note - There is such thing as a partial 1031 Exchange, where the replacement property is of lesser value than the relinquished property. In this case, you will need to pay the difference in capital gain taxes (often called the boot).
2). “Like-Kind” property means that real property has to be exchanged for real property; ie. you can’t exchange work machinery for a condo. In regards to estate property, the rules are broad to include any type of property such as a house, condo, office building, vacant land, etc.
Note - The exchange doesn’t always have to be one-for-one. In fact, you can exchange multiple investment properties for one larger investment home, and vice versa, as long as the properties meet the “like-kind” requirements and amount to the same value.
3). The name of the taxpayer and title owner must be the same on both the relinquished and replacement properties. There are processes involved in adding or removing a spouse or partnership, and a few different workarounds to get in compliance with the code. It is important that you follow proper protocol for all of the rules and regulations, or your exchange can be disallowed by the IRS.
4). There are concurrent deadlines in place regarding the timeframe for identifying your replacement property(s) and completing the exchange. The window for identifying three potential like-kind properties is 45 days from the date of your relinquished property sale. An exception is the 200% rule, where an investor can identify four or more properties as long as the value of the potential replacement properties combined does not exceed 200% of the relinquished property value. In addition to the 45-day identification window, there is a purchase window of 180 days to complete the entire exchange. These deadlines run concurrently so that after your 45-day period is up, you have 135 days remaining to complete the exchange.
Note - The replacement home purchased must be one of the properties identified in the initial 45-day period. No new properties can enter the equation after the identification window has passed.
Who handles the transactions?
Good question, while we as Realtors® help you find your three like-kind properties, a separate Qualified Intermediary (QI) must prepare the docs and hold the funds for the exchange. Oddly enough, there are no federal or state regulations for QI’s.
In fact, the majority of companies providing QI services are not bonded to the exchange, since no licensing requirements exist within the state. In the state of Florida, however, the Florida BAR client relief fund states that an attorney acting as a QI for a 1031 Exchange is bonded up to $1M per transaction. Therefore, most of our clients tend to use accountants or an attorney specializing in 1031 Exchange.
We hope this information has shed some light on what is often an unfamiliar topic for new investors. Know that the information contained in this blog is not intended to be, and should not be considered or relied upon as, legal, tax, or accounting advice.
We want to thank Dave Owens and Mike Rhinehart of Midland IRA for their help in reviewing information in this blog post. We always suggest speaking directly with a Qualified Intermediary before starting the 1031 Exchange process.
As always, don’t hesitate to reach out for more information! We have a list of great resources that we are happy to share. Simply email [email protected] or call 239-472-1950.