Identifying replacement properties in a 1031 exchange under Code Section 1031

Section 1031(a)(3) sets both periods. Property must be identified on or before the day which is 45 days after you transfer the relinquished property, and received before the earlier of the 180th day after that transfer or the due date of your return for that year, determined with regard to extensions.

That second limb catches people who sell in the last quarter. Sell in November, and your 180 days would run into May, but an April filing deadline cuts it short unless you extend. Filing the extension is what preserves the full period, and it has to be done before the original due date.

Identification is a written notice, signed, delivered before midnight on day 45 to the qualified intermediary or another party to the exchange. It cannot go to your own agent or attorney, because those people are generally disqualified.

Identify property unambiguously, normally by street address or legal description. On a property still to be built, describe it as it is expected to exist when you receive it.

Most failed exchanges we see failed here, not at the closing. Three named backups identified on day 44 are worth more than one perfect property identified on day 12.

Section 1031(a)(1) now covers only real property held for productive use in a trade or business or for investment, exchanged for real property of like kind to be held the same way. Personal property exchanges were removed at the end of 2017.

Within real property the definition is generous. An apartment building can be exchanged for raw land, a strip mall, a warehouse or a rental house. What matters is the use on both sides, not the type of asset.

What does not qualify: your primary residence, property held primarily for resale such as a fix-and-flip, and property outside the United States exchanged for property inside it. The flip case is the one that surprises people, because dealer property is inventory rather than investment property.

Note also that a cost segregation study on the relinquished property does not stop an exchange, but it does affect the numbers. See cost segregation in New Jersey.

When a 45-day window is closing and nothing suitable is available, investors look at fractional interests. They are legitimate, and they carry trade-offs worth understanding before you identify one.

• Tenancy in common. You own an undivided fractional interest in the real estate itself, which is an interest in real property. Co-owner decisions and lender requirements are the practical issues.
• Delaware Statutory Trust. A passive interest treated as an interest in the underlying real estate when the trust meets the IRS conditions. The trade-off is control: the structure sharply limits what the trustee may do, which is what preserves the tax treatment.
• Net-leased property. A single tenant on a long lease. Ordinary real estate for exchange purposes, with concentration risk in one tenant's credit.

These are securities offerings as well as real estate. Simon Klein & Co. does not sell, sponsor or recommend any of them. What the firm does is model the tax result of an option you are considering, before day 45, so the identification is made with the numbers in front of you.

Your basis carries over. The replacement property generally takes the basis of the property you gave up, adjusted for any additional cash you put in, any boot you received and any gain you recognised.

For a fully deferred exchange, two conditions usually have to hold: you acquire replacement property of equal or greater value, and you reinvest all of the net proceeds. Debt counts. Replacing a property carrying a mortgage with one carrying a smaller mortgage creates mortgage boot unless you add cash to make up the difference.

The carried-over basis is also why the depreciation deduction on the new property is often smaller than a buyer would expect. You are depreciating an old basis, not the new purchase price, apart from any additional investment.

There is no statutory holding period for an ordinary exchange. The rule people misremember as a two-year rule is the related-party rule.

Under section 1031(f), where you exchange with a related person and either of you disposes of the property received or transferred before the date two years after the last transfer that was part of the exchange, the deferral is undone and the gain comes back into income.

Outside that, the question is whether you held the property for productive use or investment. That is a question of intent, evidenced by what you actually did: how long you held it, whether you rented it, whether you marketed it for resale. Moving into a former exchange property later has its own rules and its own limits.

Federal deferral does not stop New Jersey asking for a form at the recording desk.

A seller of New Jersey real property files a GIT/REP form at closing, and the county clerk cannot record the deed without it. For an exchange, the exemption boxes 7a and 7b on the GIT/REP-3 cover fully and partially exempt exchanges. On a partial exchange, the boot remains taxable and the seller chooses between two payment methods at recording, with the consideration reconciling across the RTF-1, the GIT/REP-3 and the GIT/REP-1.

New Jersey basis is the other thing to carry forward. If you claimed bonus depreciation federally on the relinquished property, your New Jersey basis was already different, and that difference follows the exchange into the replacement property. Which form to file is covered on the GIT/REP forms.