1031 Exchanges - Partial Exchanges Are VALID

PARTIAL EXCHANGES 

"DEFER SOME CAPITAL GAIN TAXES
AND OBTAIN CASH NOW"

One of the common misunderstandings regarding exchanges, is that you must exchange the full value of the relinquished property for replacement property to have a valid exchange. In fact, a taxpayer may choose to do a partial exchange and take some of the proceeds as boot (taxable at the capital gain rate federal and state [if applicable]). If a taxpayer knows that he/she plans to do a partial exchange, it's important to make sure that the closing officer (escrow officer, closing attorney) and the qualified intermediary knows that they plan to take some of the proceeds as boot prior to closing the sale. This is important, especially if the taxpayer has an immediate need for the cash. If all of the proceeds go to qualified intermediary, then the amount that was planned to be taken as boot will be tied up in the exchange either until the exchange is complete (meets the G(6) requirements), the taxpayer fails to identify within the 45 days or after the 180th day.

Although a §1031 tax deferred exchange allows investors to defer 100% of their capital gain tax liability, some choose to only perform a partially deferred exchange.

WHAT IS A PARTIAL EXCHANGE?

In a partial exchange, the investor decides to defer some capital gain taxes and also pay taxes on either 1) cash proceeds received or 2) a reduction on their replacement property debt obligations - both of these events result in the receipt of boot which refers to any property received in an exchange that is not considered like-kind. [Cash boot refers to the receipt of cash. Mortgage boot is a term describing an Exchanger's reduction in mortgage liabilities on a replacement property. Any personal property received is also considered boot in a real property exchange transaction.]

WHEN CAN CASH PROCEEDS BE RECEIVED?

Cash proceeds can be received as follows:

1) When the Exchanger instructs the closing officer to disburse a fixed dollar amount of proceeds to them directly from the relinquished property closing;

- or -

2) After all identified property has been purchased or after the end of the exchange period if there are properties which have been identified but not purchased.

WHAT ARE THE REQUIREMENTS FOR
FULL TAX DEFERRAL IN AN EXCHANGE?

If an Exchanger intends to perform an exchange that is fully tax deferred instead of partially deferred, they must meet two specific requirements:

1) Reinvest the entire net equity (net proceeds) in one or more replacement properties;

- and -

2) Acquire one or more replacement properties with the same or a greater amount of debt. [One exception to the second requirement is that an Exchanger can offset a reduction in debt by adding cash to the replacement property closing.]

WHEN NOT TO DO AN EXCHANGE

If the boot is greater than the amount of the capital gain, then it's not recommended to do an exchange.

This information is provided for educational purposes only.  It should not be construed as tax and/or legal advice.  Individuals should consult their personal tax and legal advisors regarding the specific circumstances of their individual exchanges.

For more information, please call (877) 646-1031 or email me at LisaL@apiexchange.com  or national headquarters (800) 282-1031 or http://www.apiexchange.com/.