1031 exchange – The sale or disposition of real estate (relinquished property) and the acquisition of like-kind real estate (replacement property) structured as a tax-deferred, like-kind exchange transaction pursuant to Section 1031 of the Internal Revenue Code and Section 1.1031 of the Treasury Regulations. The goal is to defer capital gain and depreciation recapture taxes. (Click here to start your 1031 exchange process.)
200% Rule – Treasury regulation allowing an exchanger to list more than three potential replacement properties during the identification period. Using the 200% rule, an exchanger may identify any number of properties so long as their combined fair market value does not exceed 200 percent of the combined fair market value of all relinquished properties.
95% Rule – Treasury regulation allowing an exchanger to list more than three potential replacement properties during the identification period. Using the 95% rule, an exchanger may identify any number of properties so long as the exchanger closes on (receives) at least 95 percent of the combined fair market value of all identified properties.
Accommodator – An older term for a Qualified Intermediary.
“ Actual Receipt” – Occurs whenever the taxpayer has direct access to or possession of the sale proceeds of the relinquished property. Actual receipt invalidates a 1031 exchange. Also known as constructive receipt.
Adjusted Cost Basis – The modified cost of an asset to the taxpayer after adjusting for certain tax-effected items. Generally, the adjusted basis is equal to the purchase cost plus fees (commissions, escrow, title, etc.) and improvements and less accumulated depreciation and other losses (casualty, demolition).
Basis – The value of the taxpayer’s investment in a property. Sometimes described as the “cost” of an asset.
“ Boot” – Vernacular term for non “like-kind” property received by an exchanger during an exchange. Boot items are subject to capital gains tax. Examples include receiving cash from the sale of a relinquished property or failing to trade equal or up in net equity and net sales price.
Build-to-Suit Exchange – A type of exchange allowing the exchanger to make improvements on or within the replacement property. A build-to-suit exchange may be used as part of a forward exchange or a reverse exchange. (Learn more about build-to-suit exchanges.) Also known as a construction exchange or an improvement exchange.
Capital Gain / Capital Loss – The difference between the sales price of the relinquished property, less selling expenses, and its adjusted cost basis.
Capital Gains Tax – The tax levied on profits realized on the sale of investment assets such as real estate, stocks, and bonds. (Click here for our free Capital Gains Tax Calculator)
Construction Exchange – A type of exchange allowing the exchanger to make improvements on or within the replacement property. A construction exchange may be used as part of a forward exchange or a reverse exchange. Learn more about construction exchanges here. Also known as a “build-to-suit” exchange or an improvement exchange.
Constructive Receipt – Occurs whenever the taxpayer has direct access to or possession of the sale proceeds of the relinquished property.. A constructive receipt invalidates a 1031 exchange. Also known as “actual receipt”.
Cooperation Clause – Extra language in a purchase and sale agreement that explains that the taxpayer intends to include the transaction as part of a tax-deferred, like-kind exchange. This clause usually invokes the cooperation of other parties to sign necessary 1031 exchange documents.
Cost Basis – The taxpayer’s cost of acquiring a property.
Deferred Exchange – Another term for a forward exchange.
Depreciation – Periodic wear of property as expressed by the allocation of a property’s cost over a certain timeframe. The I.R.S. requires investors and business owners to take annual deductions based on the depreciation throughout a property’s “useful” or “economic” life.
Depreciation Recapture – Term for when the I.R.S. collects income tax resulting when a taxpayer disposes of an investment or business property that had provided the taxpayer depreciation deductions on past income tax returns.
Direct Deeding – Practice established by 1991 Treasury Revenue Ruling 90-34 whereby the qualified intermediary no longer must take part in the deeding of the relinquished or replacement property in exchange. Rather, the exchanger may now deed the relinquished property directly to the buyer or receive the replacement property by deed from the seller.
D.S.T. – Delaware Statutory Trust, a legal entity under Delaware law. Investors in a D.S.T. (“beneficiaries”) receive interests as direct property ownership in real property. The I.R.S. allows D.S.T. interests to qualify for 1031 treatment under certain circumstances.
Exchange Accommodation Titleholder – (aka E.A.T.) Legal entity created for the purpose of completing a reverse 1031 exchange or an improvement 1031 exchange. The E.A.T. is an unrelated party that holds legal title of either the replacement or relinquished property pursuant to Revenue Procedure 2000-37.
Exchange Period – Per I.R.C. Section 1031, the exchanger executing a 1031 exchange must complete their exchange process within 180 calendar days from the closing of the sale of their relinquished property. Remember that the exchanger only has 45 calendar days during their identification period.
Equity – The value of any ownership interest in real property or security instrument. The equity value of a potential exchange property is equal to the market value less any claims or liens against it. For example, the owner of a $2 million office building with an $800,000 existing mortgage will have $1.2 million of equity in the asset.
Exchange Agreement – A written agreement between the Qualified Intermediary and exchanger setting forth the exchanger’s intent to exchange relinquished property for replacement property, as well as the terms, conditions and responsibilities of each party pursuant to the tax-deferred, like-kind exchange transaction.
Exchanger – The taxpayer who is completing the tax-deferred, like-kind exchange transaction. An exchanger may be an individual, partnership, LLC, corporation, institution or business.
Fair Market Value – The selling price for an asset (e.g. investment property) at which a buyer and seller agree.
Fractional Interest – An undivided fractional interest or partial interest in property. See also Tenancy-In-Common Interests.
Forward Exchange – A colloquial term for a tax-deferred, like-kind exchange. Contrasted to a reverse 1031 exchange.
Identification Period – Per I.R.C. Section 1031, the exchanger executing a 1031 exchange must complete their potential replacement property identification process within 45 calendar days from the closing of the sale of their relinquished property. Remember that the exchanger only has 180 calendar days during their exchange period, which runs concurrently with the identification period. To learn more about proper identification, click here.
Improvement Exchange – A type of exchange allowing the exchanger to make improvements on or within the replacement property. An improvements exchange may be used as part of a forward exchange or a reverse exchange. Learn more about improvement exchanges here. Also known as a “build-to-suit” exchange or a construction exchange.
Intermediary – Entity acting as a middleman in a financial transaction. See also Qualified Intermediary.
I.R.C. 1031 – Section 1031 of the Internal Revenue Code (I.R.C.) allows for an exchanger to defer their capital gains tax and depreciation recapture tax in a like-kind, tax-deferred exchange of real investment properties.
Like-Kind Exchange – The means of deferring federal (and, in most cases, state) capital gains and recaptured depreciation taxes on the sale or disposition of real property and the acquisition of like-kind property. A like-kind exchange must be executed pursuant to Section 1031 of the I.R.C. and Section 1.1031 of the Treasury Regulations.
Like-Kind Property – Property that is considered exchangeable with another property in a like-kind exchange. Almost any type of property held for business or investment purpose will be considered “like-kind.” If you want to know if your property qualified for tax-deferred treatment, ask us here.
“ Mortgage Boot” – Occurs when the debt assumed on the replacement property is less than the existing debt on the relinquished property at the time of sale or disposition. Generally speaking, mortgage boot received triggers the recognition of gain and is taxable, unless offset by cash boot added or given up in the exchange. (see Boot)
Multiple Property Exchange – Disposition and/or acquisition of more than one property in a Section 1031 exchange.
Ordinary Income Tax – Tax levied by Federal and State governments on a taxpayer’s adjusted gross income. Investments that are held for less than one year are taxed at ordinary income tax rates. (See capital gain tax)
Pass-through Entity – Where the entity files an informational tax return, but the tax consequences (such as recognized income) pass through to the owners. Also referred to as a “flow-through” entity.
Partial Exchange – Arises when fewer than 100% of possible tax liability is deferred in a like-kind exchange. In the case of a partial exchange, tax liability is incurred on any non-qualifying portion; taxes are still deferred on the qualifying portion of potential gain.
Personal Property Exchange – (personal property exchanges are no longer allowable following the 2018 Tax Reform)
Principal Residence Exemption – Exclusion from capital gain tax on the sale of principal residence of $250,000 for individual taxpayers and $500,000 for couples filing jointly under I.R.C. Section 121.
Qualified Escrow Account – Ensures that the exchanger’s sale proceeds are held as fiduciary funds and wherein the exchanger is limited in their ability to receive, pledge, borrow, or obtain the benefits of the assets from the sale of the relinquished property in compliance with Treasury Regulations.
Qualified Exchange Accommodation Arrangement – A tax strategy enabling investors to capture their replacement property before selling or disposing of their relinquished property and still comply with I.R.C 1031.
Qualified Intermediary – Party responsible for processing a tax-deferred exchange transaction pursuant to section 1031 of the I.R.C. The Qualified Intermediary has no economic interest in the exchange transactions except for service compensation (exchange fee). Also known as the Accommodator, Facilitator, or simply “intermediary.”
“ Qualified Use” – An exchanger must intend to use the property in their trade or business, to hold the property for investment or to hold the property for income production in order to satisfy the qualified use test.
Real Estate Investment Trust (REIT) – A trust used to invest (primarily in real estate and mortgages) and passes income, losses and other tax items to its investors. Since REITs are typically classified as security they are not exchangeable in 1031.
Relinquished Property – Any property sold or disposed of by the exchanger as part of a 1031 exchange.
Replacement Property – Any property purchased or received by the exchanger as part of a 1031 exchange.
Reverse 1031 Exchange – The tax-deferral strategy used when the exchanger wants to acquire potential replacement property prior to selling or disposing of relinquished property. Read more about reverse exchanges here.
Safe Harbors – Term for any I.R.S. provision giving the taxpayer protection so long as certain requirements to comply with the Internal Revenue Code are met. Safe Harbors help qualified intermediaries and exchangers to structure 1031 exchanges without worry about constructive receipt issues.
Seller Carry-Back Financing – When the buyer of a property gives the seller of the property a note, secured by a deed of trust or mortgage. In a Section 1031 Exchange, seller carry-back financing is treated as boot, unless it is sold at a discount on the secondary market or assigned to the seller as a down payment on the replacement property.
Simultaneous 1031 Exchange – An exchange where the sale of relinquished property and purchase of the replacement property closer or transfer at (approximately) the same time.
Tax Deferral – The postponement of taxes to a later year, usually by recognizing income or a gain at a later time. Tax-deferred, like-kind exchange transactions are a common method of deferring capital gain and depreciation recapture taxes.
Taxpayer – The person or entity that is completing the tax-deferred, like-kind exchange transaction, commonly referred to as “exchanger”.
Tenancy-in-Common Interest – A tenancy-in-common (TIC) interest represents an undivided fractional interest in a property. Also known as “co-tenancy,” the respective co-tenants each retain the right to dispose of or borrow against their interest without the agreement of the other co-tenants. In a 1031 exchange, an exchanger may acquire a TIC interest with one or more other investors and use the interest as a like-kind replacement property.
“Three-Property Rule” – Under the three-property rule, an exchanger may identify up to three potential replacement properties without regard to their combined fair market value. This is the most common method of complying with the IRS’ rules during the identification period, largely due to the difficulty of fitting within the 200% rule or the 95% rule.