Below is a list of commonly asked questions regarding 1031 exchanges. If you are interested in learning more about 1031 exchanges, please email Michael O'Toole at firstname.lastname@example.org, Matthew Ferguson at email@example.com, or call 800-234-1031.
1031 Exchange FAQs
- What is a 1031 exchange?
“1031” is a reference to Section 1031 of the IRS Code, which allows owners of business or investment property to exchange their property for like-kind property and defer payment of taxes due on the sale of the relinquished property.
- How does a 1031 exchange work?
Once you have found a buyer for your property and before you close on your sale, you must retain a qualified intermediary (QI), which is a company that specializes in facilitating exchanges. Your QI will sell your property to your buyer on your behalf and place the proceeds from the sale into a 1031 exchange escrow account.
From the date you transfer title on the original property to the buyer, you have 45 days to identify your replacement property or properties and 180 days to close on the replacement property(ies). The QI purchases the replacement property you select using the funds in your 1031 escrow account, and transfers the property to you.
- What types of properties can be exchanged?
The IRS defines “like-kind” as any real property held for business or investment purposes. This definition includes raw land, farmland, rental properties and commercial properties. Owners of any of these types of properties can exchange them for a net-leased commercial property offered by AEI.
- What are the rules for identifying replacement property?
Your QI will assist you in completing the property identification paperwork. In completing a 1031 exchange, the IRS allows you to identify replacement property under three different rules:
- Three Property Rule: You can identify any three properties of any total value.
- The 200% Rule: You may identify any number of properties as long as the total fair market value of the properties does not exceed 200% of the value of your relinquished property.
- The 95% Exception: You can identify any number of properties with any total value but you must acquire 95% of what you identify. (This rule is rarely used for most exchangers).
- Are there any costs to do a 1031?
The IRS requires the involvement of a qualified intermediary. The fees of a qualified intermediary are generally $750 to $1,000. You, as a buyer, would be responsible for any legal, tax or other expenses that you incur on your behalf.
- How do I locate a Qualified Intermediary?
There are a number of highly experienced national and regional firms that provide QI services. AEI does not provide these services but can provide a list of experienced QIs upon request.
- Can I complete a 1031 exchange with a portion of my sale proceeds and cash some out?
Yes. You can still do an exchange to defer a portion of capital gains that would otherwise be due on the sale of your relinquished property. The portion of proceeds which you do not choose to exchange is referred to as “cash boot” and becomes taxable at federal and state levels.
- How are mortgages and debt handled in a 1031 exchange?
Generally, if you have a mortgage on your property you must take on an equal or greater amount of debt on your replacement property. The amount of sale proceeds used to retire debt on the relinquished property is considered “mortgage boot” and is subject to capital gains taxes. It is possible for you to pay capital gains taxes on the mortgage boot and complete a partial 1031 exchange with the remainder to defer a portion of the capital gains taxes.
- What taxes are involved in the sale of real estate?
It is best to consult your tax professional to calculate your individual taxes due. Generally speaking, your capital gain on the sale of real property is fully taxable at both federal and state levels. Typically, your capital gain is calculated by taking your sale price and subtracting your adjusted basis in the property and selling expenses. The following taxes may apply and may be deferred by doing a 1031 exchange:
- Long-term Federal Capital Gains – up to 20%
- State capital gains – typically the rate of state income tax. As high as 13% in some states
- Depreciation recapture - 25%
- Medicare tax – 3.8%
AEI TIC & 1031 Like-kind Exchange FAQs
- What types of properties are available from AEI?
AEI offers single-tenant, net leased freestanding commercial properties. Net leased means that the tenant - not the landlord - is typically responsible for most, if not all, of the expenses of managing and maintaining a property such as taxes and building maintenance. Our properties are all held debt free and leased only on a long-term basis to corporate credit tenants. A buyer can purchase a whole property from AEI, or a fractional interest in one or more properties as a tenant-in-common. These properties can be used to satisfy 1031 exchanges.
- What is a tenant-in-common (TIC)?
Tenant-in-common is a legal arrangement between two or more persons in which each has a deeded, undivided ownership interest in the property and all have equal rights as owners.
- Is owning a TIC interest like owning an interest in a Real Estate Investment Trust (REIT)?
No. When you invest in a REIT, you buy unit shares of an enterprise that buys, holds and sells real estate. When you buy an AEI TIC property interest, you are direct owner of real property with title and deed; and you enjoy ordinary property rights as an owner. A TIC from AEI can be used to satisfy a 1031 exchange whereas a REIT cannot.
- What is the difference between a TIC and a Delaware Statutory Trust (DST)?
Both can be used to satisfy a 1031 exchange and both are used by individuals wishing to benefit from ownership of a fractional share of property. The biggest difference between the two is that TIC owners have a deeded ownership of their property and have the ultimate control of decisions such as when to sell and whom to lease to. Those who participate in a DST are benefactors of a trust that owns property. Property decisions can only be made by the trustee, which is typically the sponsor who originally creates the DST. Additionally, terms of a DST including leases, loans, distributions, and property improvements cannot be modified.
- What are AEI's purchase requirements for buyers of tenant-in-common interests?
Buyers of a TIC must be an accredited investor at the time of purchase per SEC regulations. The minimum purchase of a TIC is $150,000.
- How are property sales prices determined?
AEI values properties based upon industry-standard methods using current rental income and capitalization rates for the type of property being offered. In addition, third party appraisals are usually obtained for each property to assist with determining its market value.
- Are there charges or fees when buying a property from AEI?
AEI does not charge the buyer any fees or commissions when purchasing a tenant-in-common interest. All sales and closing costs are paid for by the seller of the property.
- Who administers the property if I buy a tenant-in-common interest in an AEI property?
On behalf of the co-owners, AEI will oversee all administrative matters of the property including collecting and distributing rents, monitoring taxes, insurance, and all lease obligations of the tenant. Co-owners are not required to retain AEI’s lease administration services.
- What does AEI charge to administer the property?
Should a buyer wish to retain AEI as the property administrator, AEI will provide administrative services for an initial annual fee equal to $2.50 per $1,000 (0.0025) of TIC interest purchased by each buyer or $500, whichever is greater. This Administration Fee may be increased annually by an amount equal to 2% of the prior year's Administration Fee.
- What happens at the end of the lease term?
Most leases have options for extensions or renewals. In the event that a lessee does not renew a lease, AEI is available to coordinate the decisions of the TIC co-owners to re-lease or market the property for sale.
- When can co-owners sell the property?
The TIC property owners can agree to sell the property at any time. Periodically or by request, AEI will query owners with respect to their interest in selling their property. If the owners decide to sell their property, AEI will assist in doing so by locating and recommending real estate brokers or potential buyers.
- May I sell my individual TIC interest in a property?
An individual owner of an undivided fractional interest under AEI’s tenant-in-common TIC ownership structure is free to sell their property interest at any time.The consent of the other TIC owners is not required.
- Will a TIC interest pass through my estate at a stepped-up tax basis when I die?
Yes. Upon death of an owner, under current tax law, property is transferred to the heirs at a tax basis that is stepped-up to current market value.