Use this 1031 Exchange Glossary to find the terminology you can use to understand definitions of terms and phrases frequently used in the world of 1031 Exchanges.
A Section 1031 Tax Deferral permits taxpayers to reinvest the proceeds from the sale of property held for investment or business purposes into another investment or business property, and defer capital gains tax that would otherwise be due on the initial sale.
Capital gain is calculated as follows: total selling price of the relinquished property, less exchange expenses, less the relinquished property’s adjusted basis. The adjusted basis is the original cost, plus the cost of capital improvements, less depreciation or cost recovery deductions. Capital gains may be subject to depreciation recapture and other rules of the Internal Revenue Service (IRS).
You may purchase replacement property that is not yet built, provided that the improvements on the property are completed prior to the expiration of the 180 days. If the construction has not been completed prior to the closing of the replacement property, the taxpayer will only be able to receive the value of the improvements completed—not the amount spent at that time to complete the improvements. In a Construction Exchange, the property is held by a specially formed LLC called the EAT (Exchange Accommodation Taxpayer). A Construction Exchange generally has greater complexity and fees than a normal Forward Exchange.
A Contract Exchange is the tax-deferred exchange of: The Buyer’s ownership in a Sales Contract on real property, for different real property, or for a contract or option on different real property; or the Option Holder’s exchange of an Option to purchase real property, for different real property, or for an option or contract on different real property. Essentially, a contract exchange is an exchange of an open option to purchase, or an open Sales Contract, rather than an exchange of the underlying real estate itself.
Clause added to the purchase on sales agreement requiring the person who is not the exchanger to use their best efforts to assist the exchanger in consummating a 1031 tax-deferred exchange. See the cooperation clause here.
The owner of the investment property looking to make a tax-deferred exchange. Unfortunately, an exchanger cannot be an owner that wishes to defer capital gains tax on a “second home”. See like-kind property definition.
The 180-day window in which the exchanger has to complete a tax-deferred exchange. During the exchange period, there is a 45-day identification period in which the exchanger must identify which property or properties will be purchased.
Forward Delayed Exchange
A type of exchange occurs that when a property is sold (Relinquished Property) and another property is purchased (Replacement Property) within 180 days following the sale of the Relinquished Property.
The time period that begins upon the close-of-escrow of the relinquished property. During this 45-day period, the exchanger must identify the replacement property in order to continue with the section 1031 exchange transaction.
The properties involved in a tax-deferred exchange must be similar in nature or characteristics. Like-kind real estate property is basically any real estate that isn’t your personal residence or a second home and is used for investment or business purposes.
You must buy a Replacement Property of equal or greater value to the Relinquished Property in order to completely defer the applicable capital gains and depreciation recapture tax. If you purchase a replacement property of lesser value, you will be responsible for any tax on the difference. You must also use all the cash proceeds from the sale towards your replacement property purchase in order to completely defer the applicable capital gains and depreciation recapture tax. If you do not use all your proceeds on the purchase, you will be responsible for any tax on the difference.
The process in which the relinquished property is sold and all respective paperwork for that process is completed. This process is also known as the “down-leg” of the tax-deferred exchange process.
The process in which the replacement property is bought and all the respective paperwork for that process is completed. This process is also known as the “up-leg” of the tax-deferred exchange process.
Real Estate Exchange
Exchange of Investment or Business Use Real Estate for Investment of Business Use Real Estate. All types of real estate property are like-kind for other real estate property, including vacant land, residential, commercial and even in some cases, long term leases.
The procedure outlined under Internal Revenue Code Section 1031 involving a series of rules and regulations that must be met in order to take full advantage of deferring capital gains and depreciation recapture tax on the sale of investment real estate. §1031 tax-deferred exchanges are also commonly known as: Starker exchanges, delayed exchanges, like-kind exchanges, 1031 exchanges, section 1031 exchanges, tax-free exchanges, nontaxable exchanges, real estate exchanges, real property exchanges. Though all of these terms refer to the same thing, the most typical term used today is tax deferred exchange.