The amount of jargon used to describe a 1031 exchange can be mind-boggling! Use this 1031 exchange definition and terms guide to help translate lawyer-speak to layman’s terms.
If you are in possession of funds from selling the “old” property, the 1031 exchange is not valid. This rule makes it extremely important to use a qualified intermediary who can hold the funds in escrow. Read more about actual vs constructive receipt.
Any item in an exchange that is not considered like-kind property is then taxable. There are two main examples of “boot” – cash boot and mortgage boot.
Cash boot is the “net cash received” at the end of a 1031 exchange. Examples of these are a “promise to pay” from a buyer, tenant security deposits, or maintenance charges at closing.
Mortgage boot occurs when the new property mortgage is less than what’s left on the old property’s mortgage. The difference is taxed at your personal capital gains rate.
A profit from the sale of property or an investment. Capital gain tax is the amount owed the government based on the positive difference between the sale price of a property and its original purchase price.
When a taxpayer controls or has access to property, even if you do not have physical possession of the property. For example, if you receive a physical paycheck from your job on Dec 30, but do not cash it until Jan 3rd, you still pay income tax for the previous year because you had “constructive receipt.” Read more about actual vs constructive receipt.
Delaware Statutory Trust (DST)
A legal entity created as a trust under Delaware State Law. DST interests are treated as real property ownership, and eligible for a 1031 exchange. This way, multiple investors can own a part of the trust, and their portion is eligible for a future 1031 exchange. This is not possible when multiple investors invest in a property through an LLC or partnership.
Neither the property or the taxpayers need to be located in Delaware.
The portion of the gain due to depreciation deductions allowed when the taxpayer owned the property. For example, assume the original purchase price on a building was $1 million (not including land). After 10 years the owner took $250,000 of depreciation deductions on their tax bill. If the sale price is $2 million, the first $250,000 of gains will be taxed at the depreciation recapture rate (usually similar to income tax rate) and the next $750,000 is taxed at capital gains rate.
When a property is transferred directly from seller to buyer after all the exchange documents have been executed.
The ownership interest you have in a Delaware Statutory Trust. Similar to an LLC or real estate partnership, but maintains eligibility for a 1031 exchange.
Person or entity that creates a Delaware Statutory Trust to hold property and helps divide beneficial interest to investors.
An entity that has a fiduciary responsibility in the transfer of property from one person or company to another. Holds funds and only releases once an agreement is fully completed.
Exchange Accommodation Titleholder (EAT)
An entity used to complete a reverse exchange or improvement exchange. In a reverse exchange, the EAT holds title to the new or old property until the old property is sold to a buyer. In an improvement exchange, the EAT hold the title to the new property and makes improvements before giving the title to the exchanger.
An agreement that outlines the transfer of the old property to a qualified intermediary and terms for exchange proceeds during the 180-day exchange period
The 180 days to complete an exchange and submit paperwork to the IRS, or the due date of taxes – whatever is earliest.
The person or company who is performing a 1031 tax-deferred exchange. NOT the qualified intermediary or EAT.
The form filled out and submitted to the IRS to complete a 1031 exchange. You can download form 8824 here.
Used for the transfer or sale of property from one person or entity to another.
45 day period from closing on old property to identify a new property or properties
The new property must be identified after 45 days of selling the old property (vice versa in a reverse 1031 exchange). You are allowed up to three. You do not need to be under contract or in escrow on the new property, you only need to notify your qualified intermediary
Improvement 1031 Exchange
Also called Build to Suit 1031 exchange or Construction 1031 exchange. Allows you to use 1031 exchange funds to improve the new property
Something of value that cannot be touched or held. Examples of intangible property are stocks, bonds, or intellectual property. As of January 1, 2018 (from the 2017 Trump tax bill), no form of intangible or personal property is eligible for a 1031 exchange.
The money earned by a lender during a certain time period. In the context of a 1031 exchange, after a property is sold the funds are held by a qualified intermediary. These funds accrue interest income, and a split of the proceeds is usually arranged.
Internal Revenue Code (IRC)
Federal statutory tax law in the United States, enforced by the Internal Revenue Service (IRS)
Internal Revenue Service (IRS)
The revenue service of the United States government. Bureau of the Department of Treasury, run by a commissioner who is appointed to five-year terms by the president. Responsible for collecting taxes and administering the Internal Revenue Code (IRC)
A tax-deferral strategy on the sale of an investment or business property, as defined in section 1031.
Property used as a business or an investment and the same type as the property being exchanged. For example, a single-family home can be exchanged for a multi-family. On the other hand, a property in the US cannot be sold and exchanged for a property in Canada. Vacant land is always considered “like-kind.”
Part of Section 1031 that states the taxpayer listed on the old property must be the same as the new replacement property. For example, if a husband and wife are both on the deed to the old property, BOTH must be on the deed for the new one. The same goes for a trust or corporation.
A lease arrangement where the tenant takes responsibility for a majority of the repairs and maintenance. Examples include HVAC, roof repairs, or plumbing. Investors will sometimes use a 1031 exchange to exchange multiple properties into one that can be leased NNN. This reduces the headache of maintenance and management.
The Opportunity Zone program began life as the bi-partisan Investing in Opportunity Act which was included in Trump’s Tax Cuts and Jobs Act of 2017. The program allows individuals to take unrealized capital gains and invest them in lower-income area real estate and small businesses.
Opportunity Zone Fund
An investment vehicle organized for the purpose of investing in an opportunity zone property. Currently, individuals are able to “self-certify” that they are a fund and attach aform to their tax return. No approval by government committees or the IRS is needed.
When the taxpayer places their new property under ownership with an Exchange Accommodation Titleholder (EAT) while the exchange is completed. This is used because you are not allowed to hold title to the new and old property at the same time.
Partial 1031 Exchange
When the “new” property’s value is less than the proceeds from the “old” property sale. The remainder is considered “boot” and is subject to both capital gains and dividend recapture tax.
Any possession that is movable and owned by someone. I.e. Not land, and not a building. Can be either tangible (office furniture, a tractor) or intangible (stocks, bonds, intellectual property). Starting with the 2017 Tax Bill, personal property is no longer eligible for a 1031 exchange.
A tool that enables a person or company to be contractually obligated to pay a sum of money plus interest in exchange for a loan.
Qualified Exchange Accommodation Agreement
An agreement entered between the taxpayer and the Exchange Accommodation Titleholder (EAT). Needs to adhere to 3 terms 1) The EAT is holding property to facilitate a reverse 1031 exchange 2) You and the EAT will report all ownership, holding, and sales to the IRS 3) The EAT will be treated as the owner for tax purposes
Qualified Indicia of Ownership
Term that a party must hold legal title (e.g. contract) to a parked property during a reverse 1031 exchange.
The organization that facilitates a 1031 exchange for a taxpayer. Has four traits 1) Cannot be a related party 2) Does receive a fee 3) Receives the old property from exchanger and sells to the buyer 4) Buys the new property from the seller and transfers to the taxpayer
Part of Section 1031 that establishes old property and new property were held as rentals, investment properties, or used in a small business
Land and any property attached to it.
Related Parties Transaction
A business deal or agreement between two parties that have a prior personal or business relationship. Related Parties Transactions are legal but do require disclosures during a 1031 exchange.
The “old” property being sold.
The “new” property being purchased. Replaces the “old.”
Instead of selling the old property then buying a new one, the taxpayer buys a new property before the old property is sold. Commonly used in seller’s markets where there is more demand for properties than supply.
In a 1031 exchange, this refers to one of the four procedures for structuring a delayed exchange.
Section 1031 of the IRC established the rules for executing an exchange of property to defer capital gains tax.
Section 1033 of the IRC established that loss of property because of natural disaster or eminent domain can be exchanged on a tax-deferred basis for a like-kind property. Replacement timeline is up to 2 years for natural disaster and 3 years for eminent domain.
The person who will be managing the Delaware Statutory Trust (DST). In a DST there is also an independent trustee who represents the interests of the lender or beneficiaries. The third person is the Delaware Trustee who maintains a physical Delaware address.
Special Purpose Entity
Used in corporate finance and reinsurance firms to keep assets separate from the rest of an organization. In the context of a reverse 1031 exchange, they are used for acquisition of properties.
Another name for a 1031 or like-kind exchange. Name comes from the landmark case that established the tax benefits of a 1031 exchange.
Instances where a taxpayer can delay paying taxes until a future date
The person or company that instructs a qualified intermediary to conduct a 1031 exchange on their behalf.
Tenant In Common (TIC)
Type of shared ownership where share of property can be of different sizes. Read more about tenant in common vs joint tenancy
In real estate, a property that is not owned by an individual but through a trust. Examples of trusts include a land trust, Delaware Statutory Trust, holding trust, living trust, and more.
Umbrella Partnership Real Estate Investment Trust (UPREIT) is when a taxpayer gives an existing REIT his/her property in exchange for shares that equal the value of the property. Once an UPREIT exchange is done, the shares in the REIT are personal property and not eligible for a 1031 exchange. Section 721 governs this term, it is related but separate from a 1031 exchange.