A 1031 exchange is a transaction that allows taxpayers to sell an asset that is held for investment or business purposes, use the sale proceeds to purchase a “like kind” asset, and defer paying capital gains taxes. Like any investment discipline, 1031 exchanges involve specific terminology.
When investors are familiar with this terminology, they find it easier to discuss 1031 exchanges with brokers. Below are frequently used terms in 1031 exchanges.
- Exchanger –The property owner who attempts to sell property and to defer capital gain taxes by completing a 1031 tax exchange.
- Relinquished Property (a.k.a. exchange property) – The real estate the exchanger sells. Most 1031 exchanges start with the exchanger selling the relinquished property.
- Replacement Property (a.k.a. acquisition property) – The property the exchanger purchases. 1031 exchanges are completed when the exchanger acquires this property.
- Identification Period – The period of time in which exchangers must identify the property they will purchase. This period begins on the day the relinquished property is transferred and ends at midnight 45 days later.
- Exchange Period – The period of time in which exchangers acquire new properties. This period ends 180 days after the date when the person transfers the relinquished property, or on the due date of the person’s tax return for the year in which the transfer of the relinquished property occurred, whichever comes first.
- Qualified Intermediary (QI) – An entity that facilitates 1031 exchanges. The QI has several responsibilities, including: coordinating with the exchangers and their advisors to structure a successful exchange, preparing documents for the relinquished property and the replacement property, and holding documentation of the identification period.
- Constructive Receipt –A term that refers to the exchanger having unrestricted control of the equity from the property sold. Constructive receipt of sale proceeds invalidates a tax deferred exchange.
- Boot (a.k.a. equity) –The part of 1031 exchanges that is taxable. To defer taxes, the exchange must be constituted of “like kind” properties that are held for business or investment purposes. The exchanger must pay taxes on the cash boot or mortgage boot if the replacement property is not of equal or greater value than the relinquished property.
- Like Kind Property –Any properties that share the same nature or character. To qualify as like kind, properties must be of the same type, but need not be of the same quality. Real properties are generally like kind, regardless of their condition.
- Investment property – A property the owner does not inhabit and holds for investment purposes. The term investment property can apply to residential, retail, and commercial real estate property, to name a few.
The terms above are commonly used in reference to 1031 exchanges. Knowing these terms will help you discuss 1031 transactions with your broker. If you are interested in making a real estate investment using a tax-deferred exchange, Westwood Net Lease Advisors will help you choose the right property.
Note: Before you move forward with a real estate investment, it is recommended that you hire a real estate attorney and a CPA to oversee the legal and financial aspects of the deal. Having these professionals on your side will help you complete the transaction in an accurate, timely manner.