What Are the Different Types of Exchanges?
1031 exchanges allow property owners to sell their properties and reinvest the proceeds into like-kind property while deferring the capital gains tax on the sold property. But the story does not end there; there are several different types of 1031 exchanges that allow taxpayers to accomplish various goals. While some of these exchanges can be more complex than others, they nonetheless accomplish the same goal of allowing taxpayers to avoid capital gains tax. If you are considering a 1031 exchange as a tax strategy, a 1031 qualified intermediary can help you decide which type is best for you.
A simultaneous exchange is an exchange wherein the closings for the relinquished property and the replacement property occur on the same day. A simultaneous exchange can occur in one of three ways: (1) a “swap” exchange, in which the parties exchange deeds with each other, (2) a “three-party” exchange, where the titles pass through a third-party intermediary, or (3) a simultaneous exchange with a qualified exchange intermediary, wherein the qualified intermediary is used to facilitate the exchange. The swap-type exchange is uncommon, as it is rare for two property owners to want to exchange each other’s properties at the same time.
Delayed exchanges, also known as “forward” exchanges, are the most common type of 1031 exchange. With this method, there is a time gap between the transfer of the relinquished property and the acquisition of the replacement property. After relinquishing their property, the taxpayer has 45 days to find a potential replacement property. The acquisition of the replacement property must then be completed within 180 days after the transfer of the relinquished property or the due date of the taxpayer’s federal tax return for the year in which the relinquished property was transferred, whichever is sooner.
A reverse exchange is the opposite of a delayed exchange. Instead of the taxpayer selling their property and then finding a replacement, the taxpayer purchases a replacement property before selling their existing property. These types of exchanges are commonly used when the taxpayer finds an ideal replacement property but isn’t quite ready to sell their existing property or hasn’t found a buyer yet. This type of exchange requires the use of an Exchange Accommodation Titleholder (EAT), wherein the EAT acquires and holds title to the target property in a separate special purpose entity. Within 180 days, the taxpayer sells the relinquished property and the EAT transfers the replacement property to the taxpayer.
Construction and improvement exchanges are variations on standard 1031 exchanges. These types of exchanges allow the taxpayer to use the sale proceeds from the relinquished property to buy vacant land and construct new property on it or buy existing property and make improvements to it. The construction or improvement must be begun within 180 days from the date the taxpayer’s property is relinquished and finished within two years of that date. This can be risky, as there is no guarantee that the construction or improvements will be finished within two years.
A partial exchange allows a taxpayer to defer paying taxes only on a portion of the capital gains from the sale of their property. With this type of exchange, the taxpayer reinvests a portion of the proceeds from the sale into a like-kind property but takes the remaining portion as cash. The portion that is reinvested is tax-deferred, while the portion that is taken as cash is subject to tax. While the portion taken as cash is taxed, a partial exchange allows the taxpayer more flexibility than a full deferral.
Personal Property Exchange
Prior to the Tax Cuts and Jobs Act of 2017, personal property — such as machinery, equipment, vehicles, aircraft, artwork, intellectual property, and intangible business property — was subject to 1031 exchanges. That is no longer the case. However, certain assets — such as mutual ditches, reservoirs, and irrigation stock — are still eligible for such exchanges. Readers interested in personal property exchanges should speak with a 1031 qualified intermediary for more information about whether their personal property is eligible.
Contact a 1031 Qualified Intermediary for More Information
As you can see, there are many considerations to take into account when deciding whether to pursue a 1031 exchange strategy, and not all types of 1031 exchanges are ideal for all taxpayers. To determine whether — and which type — of 1031 exchange is right for you, please consider speaking to an expert. To get started, please contact a qualified intermediary at 1031 National Services by calling 888-872-1031 or using our online contact form.