One of the most common misperceptions many long-term duplex, triplex and fourplex sellers have is they can take the proceeds from the sale of their property, put it in their bank, then buy a property later and call it a 1031 exchange.
The fact is, that’s a proven path to incurring depreciation recapture and capital gains tax. That’s because any time you touch the money, the IRS views it as you cashing out.
To do a 1031, also known as a Starker exchange, the IRS requires a number of things to happen.
First, the seller must include a disclosure in the purchase agreement, disclosing to the buyer of the relinquished property of their intention to perform a 1031 exchange.
Next, the seller must select a qualified intermediary. This is a neutral third party, usually a company, designated by the seller to receive the proceeds of the sale. The “QI” facilitates makes sure the paperwork and timing is in full compliance with IRS rules, and when the time comes to close on the replacement property, makes sure proceeds from the sale of the replacement property are transferred to and applied toward the purchase.
The seller has 45 days from the day of closing to identify up to three replacement properties. They must close on the purchase of one of these three within 180 days of the date of closing on the relinquished property.
In other words, it’s important to have a clear plan before putting the property on the market. In fact, many sellers start shopping for their replacement property either just before or when they put the property on the market.
There’s a lot to remember with a 1031 exchange. If you can’t retain it all, then simply remember this.
If you touch the money, even if it’s simply wired into your bank account, you’re taxed.