CLA | The Nuances of Section 1031 Exchanges (Part One in a Series)

As previously discussed, the Biden Administration’s American Families Plan includes a proposal to partially repeal deferred gains from Section 1031 exchanges. The proposal would implement a limit on gains eligible to be deferred to $500,000 per taxpayer (or $1 million for married individuals filing a joint return) for each year for real property exchanges that are like kind. Any gains from like-kind exchanges in excess of these thresholds would be recognized by the taxpayer in the year of sale. The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2021. While not completely spelled out in President Biden’s American Families Plan announcement or in the Treasury Department’s “Greenbook,” it is presumed that all like-kind exchanges currently in process will need to be completed by December 31, 2021 in order to be eligible for gain deferral treatment under current tax law.

With approximately 160 days left in the calendar year, we will devote the next couple of blog posts to the nuances of Section 1031 exchanges, starting with the all-important identification period.

The identification period begins on the date that the taxpayer transfers the relinquished property and concludes 45 days later. The replacement property (or properties) must be identified in writing, signed by the taxpayer and provided to an independent agent such as a qualified intermediary. If more than one property is relinquished, the earliest transfer date determines when the 45-day clock starts. The replacement property (or properties) identified do not have to be under contract, and the taxpayer does not have to acquire everything that is identified; however, the replacement property (or properties) that are acquired must be substantially the same property (or properties) that were identified during the identification period. Any property that is acquired during the 45-day period is deemed to have been properly identified.

During the identification period:

1. The taxpayer is permitted to identify up to three replacement properties without regard to their fair market value.
2. If more than three properties are to be acquired, the aggregate fair market value at the end of the identification period cannot exceed 200% of the aggregate fair market value of the relinquished property (or properties).
3. The taxpayer may identify any number of replacement properties of any value provided that 95% of the fair market value of all replacement properties identified are received before the end of the exchange period. The exchange period also begins on the date of transfer of the relinquished property and ends on the earlier of 180 days thereafter or the due date, including extensions, of the tax return for the year in which the transfer of the relinquished property occurs.

Most taxpayers choose to follow the “three-property rule” due to its simplicity. The “200% rule” and the “95% rule” require careful planning. Real estate industry colleagues Ken Zacharias and Jake Caelwaerts are just two of the talented professionals at CLA that are here to assist you with all facets of your Section 1031 exchange!

Author:

• Carey M. Heyman, Principal, CLA

Compliments of CliftonLarsonAllen – a member of the EACCNY.