Delayed Exchange
The original “swap” of two properties under 1031 was just that, an exchange between two people for two properties, but these days it’s much more likely that you’re not swapping ideal pieces of investment properties between neighbors. There is usually a gap between the time you sell your property and obtain a new one. This is referred to as a delayed exchange. For this type of exchange, you’ll need to find a Qualified Intermediary, aka a money man, to hold your proceeds and purchase the new property for you.
There are also reverse exchanges for those investors who first purchase a new property and then identify other properties they own to relinquish in the exchange.
Identifying Replacement Properties
In a delayed exchange, there are two key deadlines that need to be met. After the sale of the initial property, you have 45 days to notify your intermediary of the property you want to purchase with the proceeds. The good news is, you aren’t limited to just one. You can identify up to three properties with no limits on their fair market value, but you must close on at least one. Another option is to identify 4 or more properties as long as their combined fair market value does not exceed 200% of the value of the relinquished (sold) property. The last, and most dangerous option, you can identify an unlimited amount of properties, but you have to close on 95% of them.
The next critical deadline is the closing on the new property. It must occur within 180 days of the sale of the previous property, known as the exchange period.
Avoid the “Boot”
No, they won’t kick you out, but you could stand to get money back if your exchange isn’t exactly equal. That amount you get back is called “boot”, and it’s taxable. This could happen if you sold a property for $100,000, but only purchased a $90,000 replacement investment. You would be taxed at capital gains rates on $10,000. The more likely scenario getting investors in trouble with boot is forgetting to account for mortgages. Even if you don’t receive cash back, a decrease in liability, like a lesser mortgage on the new property, is still a taxable gain.
Note the costs associated with acquiring the property, such as inspections and some closing costs do count towards your total cost of the new property.
