FAQs
General Issues
A. If I receive cash or a note in an exchange will this still qualify for a tax deferred exchange?
B. What is considered a “Like Kind” Property?
C. Can I exchange for a property outside the U.S.?
D. Can I add additional funds to acquire a Replacement Property?
E. What should I look for in a Qualified Intermediary (“QI”)?
Time Requirements
A. What are the Time Requirements?
Identification Issues
A. What are the Identification Requirements for the Replacement Property?
B. What if I can’t find the Replacement Property within 45 days?
C. What if I decide to forfeit the exchange after identifying Replacement Properties?
D. What happens after I identify my Replacement Properties?
State Tax Withholding
A. What are the CA Withholding Requirements?
Security Issues
A. How can I ensure that my exchange funds are secure?
Title Issues
A. What are the issues on taking title on the properties?
Wire Transfer & Fees
A. How does Mid-Cal Realty Services, Inc. transfer monies to and from escrow?
B. At what time does Mid-Cal Realty Services, Inc. need to be notified to do a same day wire transfer?
C. Does the escrow officer need to pay through escrow Mid-Cal Realty Services, Inc. for the exchange administration fee?
1. General Issues
A. If I receive cash or a note in an exchange will this still qualify for a tax deferred exchange?
Assuming you have met all other requirements under IRC Section 1031, receiving cash or a note along with real estate (“Like Kind” Property) in an exchange, will not disqualify the transaction as a tax deferred exchange. However, since cash and notes are not “like kind” to real estate, generally speaking cash and/or notes received in an exchange will be taxable (“non- like kind” property is considered “boot”).
B. What is considered “Like Kind” Property?
According to Treasury Regulation 1.1031 any type of real estate is “like kind” to real estate. So, for example, a commercial building is “like kind” to industrial property. Residential rental property is “like kind” to vacant land. As you can see the definition of “like kind” property is quite liberal. Remember, however, the more stringent definition requires both the Relinquished Property and the Replacement Property to be held for productive use in a trade, business or for investment.
C. Can I exchange for a property outside the U.S.?
Prior to 1989 this was possible. However, current law requires that both the Relinquished Property and Replacement Property be U.S. property.
D. Can I add additional funds to acquire a Replacement Property?
Yes. It is certainly okay to contribute additional funds to supplement exchange monies to acquire a Replacement Property. Adding funds is a common occurrence and presents no problem in effecting a valid exchange. On the other hand, taking money out of an exchange presents a host of potential issues which could create unintended tax consequences.
E. What should I look for in a Qualified Intermediary (“QI”)?
At this time QI’s are not regulated by any Federal or California agency. Due to the fact that exchange transactions involve substantial dollars and tax savings, you owe it to yourself to find an experienced, knowledgeable and trustworthy professional that can guide you through the complex exchange rules. When looking for a QI be sure to speak with the individual who will be handling the structuring, documenting and implementing of your exchange.
2. Time Requirements
A. What are the Time Requirements?
45 Day Requirement: From the date the Relinquished Property is disposed of, you have 45 days to identify your Replacement Properties.
180 Day Requirement: From the date the Relinquished Property is disposed of, you must complete the acquisition of the Replacement Property within the lesser of 180 days or the due date of the income tax return (including filed extensions) for the year in which the Relinquished Property is disposed of.
3. Identification Issues
A. What are the Identification Requirements for the Replacement Property?
The I.R.S. has adopted final regulations which detail the requirements in properly identifying Replacement Property. Under these Regulations, the identification must be in writing AND must be sent to the Qualified Intermediary (“QI”) on or before the 45th day after the transfer of the Relinquished Property.
There are two alternative methods in calculating the number of properties or value of the property(ies) which are to be identified.
Under the first method you can identify up to three Replacement Properties with an unlimited aggregate fair market value measured on the 45th day.
The second method allows you to identify an unlimited number of Replacement Properties so long as the aggregate fair market value as of the 45th day does not exceed two hundred percent of the fair market value of the Relinquished Property.
If you identify more than three properties then in order to salvage the exchange it is necessary to acquire essentially all (95% of the total fair market value) of the properties which were identified.
The IRS recommends that the Replacement Property be unambiguously identified by either the property address and/or the legal description. The identification document should be sent to the QI via hand delivery, mail, telecopy or otherwise.
B. What if I can’t find the Replacement Property within 45 days?
If no Replacement Property is identified by the 45th day you have a taxable transaction. There is no possibility of a valid IRC Section 1031 exchange. The proceeds from the disposition of the Relinquished property will be disbursed on the 46th day from the day escrow closed on the Relinquished Property and state income tax, if applicable, will be withheld and sent to the state in which the transaction took place.
C. What if I decide to forfeit the exchange after identifying Replacement Properties?
Except in limited circumstances, until the entire 180-day time period passes without your using up the net equity in the Relinquished Property to acquire Replacement Propert(ies), you cannot elect to receive cash instead of property. Common exceptions to this general rule occur when Replacement Properties you have identified have either all been acquired or prove impossible to acquire due to circumstances beyond your control.
D. What happens after I identify my Replacement Properties?
Once you determine which Replacement Property(ies) you intend to acquire and notify us of this, we prepare our exchange documents, which become part of the Replacement Property Acquisition Agreement.
4. State Tax Withholding
A. What are the CA Withholding Requirements?
California requires 3.33% withholding on the gross sale price of real property. If the disposition of the property is part of a 1031 exchange transaction, the transaction is exempt from CA withholding.
Sometimes you may be subject to California withholding even if an exchange occurs. If cash is received as part of an exchange, you will be subject to California income tax withholding on this cash received (known as “boot”) at the rate of 3.33%.
If the exchange fails, the withholding will be 3.33% of the gross sale price of the Relinquished Property or 9.3% of the taxable gain.
5. Security Issues
A. How can I ensure that my exchange funds are secure?
Qualified Intermediaries (“QI”) are in possession of exchange funds between the disposition of a Relinquished Property and the acquisition of a Replacement Property. The reason why exchange funds are held by the QI during this time is to avoid the constructive receipt issue.
If you constructively receive the proceeds from the disposition of a Relinquished Property then the tax deferred exchange is invalidated. The IRS allows certain security arrangements to provide security for exchange funds held by the QI without creating a constructive receipt issue.
There are basically four types of security arrangements the IRS has approved
1. Qualified Escrow Account
2. Qualified Trust Account
3. Third Party Guarantee
4. Stand By Letter of Credit
You can use any of the above arrangements to secure their exchange funds while these funds are held by the QI. Using such an arrangement does not compromise the validity of the tax deferred exchange in the eyes of the IRS.
6. Title Issues
A. What are the issues on taking title on the properties?
Generally speaking, if you disposed of the Relinquished Property, you must acquire the Replacement Property to affect a valid exchange. So, for example, if a partnership or corporation is affecting an exchange and disposes of a Relinquished Property then this partnership or corporation, as opposed to the partner or shareholder, should acquire the Replacement Property. You must pay particular attention to this basic principal when properties to be exchanged are owned by partnerships, wholly owned corporations and limited liability companies.
7. Wire Transfer & Fees
A. How does Mid-Cal Realty Services, Inc. transfer monies to and from escrow?
Unless instructed otherwise, all monies are transferred via wire only after written authorization.
B. At what time does Mid-Cal Realty Services, Inc. need to be notified to do a same day wire transfer?
In order to process a transfer request we typically require 24 hour notice.
C. Does the escrow officer need to pay through escrow Mid-Cal Realty Services, Inc. for the exchange administration fee?
No, Mid-Cal Realty Services, Inc. is typically paid directly from exchange funds at the completion of the exchange.