1031 Real Estate Exchanges in Eugene, Oregon
As a real estate broker in Eugene, Oregon, I get asked about a 1031 Exchange a lot. Clients who own investment property often want to learn more about taking advantage of the tax deferral allowed through the 1031 Exchange. Trying to work through the process can be confusing at best, and some are simply not aware that it exists.
What is the 1031 Exchange?
Under Section 1031 of the US IRS Code, a taxpayer may be able to defer capital gains and any federal tax liability. This is not an across the board application as it only applied to certain types of property. A tax-deferred exchange doesn’t apply to sales of second homes or primary residences. They only apply to certain types of investment properties. A tax-deferred 1031 exchange can be a powerful tool for building wealth. However, you will need the assistance of a real estate broker and a tax advisor to make sure you meet all the requirements as described in the Internal Revenue Code Section 1031. If you do not meet the specified requirements, it can end in immediate tax liabilities and penalties. There is also a strict timeline and procedure for a 1031 Exchange. I find Cascade Title in Eugene, OR to a great resource.
What are the 1031 Requirements?
The 1031 requirements have to be followed to the letter if you want to realize the benefits of the investment and avoid some costly penalties. Firstly, a Qualified Intermediary will need to facilitate the exchange process. They hold the proceeds from the property you have sold. These funds are held until they are ready to be reinvested in the replacement property. You will need a written “exchange agreement” with the Qualified Intermediary. This will prevent you from having access to the funds in the exchange period.
What does the QI do?
The QI has to complete a valid 1031 exchange to ensure equity is preserved and all the roles are followed appropriately during the process. They will act as an independent third party to help facilitate the exchange. Treasury Regulations established this as a safe harbor. This makes it very important to select the QI before the property is even sold.
What types of Eugene, OR properties qualify?
In order to do an exchange, it will have to be on like-kind properties. This is a very liberal qualifications and for the most part most real estate properties will qualify. However, other securities, REITs, and other real estate funds, and do not qualify for an exchange. Types of like-kind properties might include:
- Storage Facilities
- Raw Land
- Industrial Facilities
- Multi-Family Rentals
- Office Buildings
- Single-Family Rentals
- Retail Shopping Centers
In an exchange, like-kind properties should be similarly valued. When there is a difference in the value of the property and the property being exchanged, it is called “boot.” This cash boot is taxable if the property sold is of more value than the replacement property. A mortgage is permissible on both sides of an exchange. The difference between two mortgages can also create a boot which is taxable. These factors need to be considered when you are calculating an exchange and its parameters.
There are some fees and expenses that can affect the value of a transaction and these can impact the potential boot too. Some expenses that can be paid for using exchange funds include:
- The commission for the broker
- Some intermediary fees
- Fees for filing
- Attorney’s fees
- Premiums for title insurance
- Tax adviser fees related to the exchange
- Finder fees
- Escrow fees
Exchange funds cannot be used to pay for:
- Fees for financing
- Property tax
- Maintenance or repair costs
- Insurance premiums
The Strict 1031 Exchange Timeline
The exchange has strict rules and timeline that have to be followed closely. For instance, you must identify the properties in the exchange within 45 calendar days of the relinquished property’s closure. This must follow these rules:
- The Three-Property rule includes identifying up to three properties without regard to the total value of the identified property.
- The 200% Rule identifies any number of properties with a combined Fair Market Value (FMV) doesn’t exceed 200% of the value of the relinquished property.
- The 95% Rule identifies any number of properties as long as at least 95% of the property is ultimately acquired without regard to the aggregate Fair Market Value.
Also, the replacement property (or properties) must be closed on within 180 calendar days from the relinquished properties closure.