Oregon REALTORS® Forms allow 1031 Exchanges whenever one of the parties intends to pursue the transaction as a part of the like-kind exchange. There is a notice of intent requirement, and in-built cooperation requirements, and the exchanging party indemnifies their counterpart from any issues arising from the exchange.
The Internal Revenue Code section 1031 allows a person to postpone taxes on sales of investment properties when the proceeds are used to purchase a similar property. It’s also known as a “like-kind exchange.” There are several ways that a 1031 exchange can happen. The simplest is to simultaneously swap the properties, and the more complicated ones involve deferred exchanges [no more deferral than 180 days, generally it requires a facilitator to follow the income tax rules]. Both properties [the sold one and the purchased one] must be held for investment, if the owner uses the property for personal use, such as a vacation home or primary residence, the like-kind exchange is not available. The properties need to be the same “nature, character or class.” This sameness is a broad standard, IRS guidance notes that most real estate is like-kind with other real estate; for example, real property with a residential rental house is “like-kind to vacant land.” The properties being exchanged do all need to qualify as investment property or business property for the exchange to take place, an investment property cannot be exchanged for a vacation home. A notable exception is that property within the United States is not considered like-kind to property outside the United States. Also worth noting that personal property is never like-kind to real property, so a manufactured home, unaffixed to the ground, is not going to be exchangeable for real property.
If a client sells property and plans to do a like-kind exchange, they have to identify the potential replacement property within 45 days. There will need to be a writing that is signed by the buyer and given to the seller of the replacement property or to a “qualified intermediary.” If the client gives notice to an attorney, accountant, or real estate agent, but not to the Seller of the replacement property, the notice is not sufficient. The writing will also need to identify the replacement property by using either a legal description, street address or distinguishable name [e.g. calling it “Black Acre” is fine if it’s the only one named that]. The replacement property purchase has to be completed and client needs to have ownership of the property within 180 days after the sale of the original property [the one that is being “exchanged” for the new property] or within 180 days after the due date of the income tax return of for the tax year in which the relinquished property was sold, whichever was earlier. The exchanger will need to file a Form 8824 with the IRS alongside their tax returns.
At all times, if a client wants to do a 1031 exchange, you should advise they contact a tax professional. Mistakes can be costly, and many promoters of like-kind exchanges may advertise them as “tax-free” when the exchange is actually a tax deferral. If there is money leftover in the sale/exchange, the exchanging party may find themselves paying capital gains taxes on that. If the replacement property has a lower rate mortgage, the exchanger may find themselves being taxed on the difference in value. If the sale falls through, the exchanger may find themselves suddenly subject to taxes. Tax professionals can help guide the client through these risks if they wish to do a 1031.