How Do I Complete a 1031 Exchange Application?

There is no 1031 exchange application to file with the IRS, and no agency approves an exchange in advance. You complete a delayed exchange (sell first, buy later) by signing an exchange agreement with a qualified intermediary before your sale closes, identifying the replacement property in writing within 45 days, closing on it within 180 days, and reporting the exchange on Form 8824 with your tax return. The "application" forms you may be handed are the intermediary's intake paperwork. They open your file, but only the steps below make the exchange valid.

A 1031 exchange is one of several tax rules for property owners; tax benefits available to homeowners covers the ones that apply to a home you live in.

What paperwork does a 1031 exchange involve?

A QI is a company that holds your sale money under a written agreement so that you never receive it. The IRS publishes no standard form for the exchange agreement, the assignments, or the identification notice. The QI usually drafts them, and the federal deferred-exchange regulations set what each one must contain.

Step-by-step: completing a delayed exchange

1. Confirm both properties qualify. The property you sell (the relinquished property) and the property you buy (the replacement property) must both be real estate held for investment or for use in a business. Your home and a house you are renovating to resell do not qualify, and U.S. property cannot be traded for property outside the United States. What a 1031 exchange is explains these rules.
2. Hire a QI and sign the exchange agreement before closing. If you receive all of the sale money, or can draw on it, before you buy, the transaction becomes a taxable sale. Cash you take out of the deal is taxed as boot, explained below, while the rest of the gain can stay deferred. The agreement must say you have no right to receive, pledge, or borrow against the funds until the exchange ends. Your attorney, accountant, or real estate agent from the past two years cannot be your QI; whether you need an intermediary lists who can serve and how to check one.
3. Assign the sale contract and close the sale. You assign your rights under the sale contract to the QI, and the buyer must be told in writing on or before closing. Give the closing agent the QI's wiring instructions so the net proceeds go to the QI, not to you. Both deadlines start on the closing date.
4. Deliver the identification notice by day 45. Describe each property by street address, legal description, or a distinguishable name, sign the notice, and send it to the QI or the seller of the replacement property. Sending it only to your attorney, real estate agent, or accountant does not count. Most people name up to three properties; how long you have to complete a 1031 exchange covers the limits on naming more.
5. Line up replacement financing. Apply for any loan as soon as you sign the purchase contract so underwriting finishes inside the 180 days. Fannie Mae accepts 1031 exchange funds as the down payment on a conventional loan when they are properly documented and the exchange complies with the tax rules, so have your exchange agreement and the QI's statement of funds held ready for the lender. To defer all of the gain, the new loan plus any cash you add must equal at least the mortgage paid off when you sold.
6. Assign the purchase contract and close by day 180. The QI takes your place in the purchase contract, the seller gets written notice, and the QI wires the exchange funds to the closing. You must receive the property by day 180 or by your tax return's due date, including extensions, if that comes first.
7. Report the exchange on Form 8824. File it with your return for the tax year in which you transferred the relinquished property, even if the purchase closed the following year.

How do you fill out Form 8824?

Form 8824 draws on three sets of records: the QI's file, the two settlement statements, and your own records of what you paid for the old property, the improvements you made, and the depreciation you claimed or were entitled to claim. Those last records set the old property's adjusted basis, which the form needs to figure your gain.

• Part I, lines 1 through 6: the address and type of each property, the date you originally acquired the property you gave up, the date you transferred it, the date of your written identification notice, and the date you received the replacement.
• Line 7 and Part II: whether the exchange involved a related party, such as your spouse, child, parent, grandparent, grandchild, or sibling, or a company you control. If it did, you also file Form 8824 for each of the next 2 years, and the deferred gain becomes taxable if either of you sells the exchanged property within those 2 years, with limited exceptions. Buying your replacement from a related party who receives cash generally does not qualify at all.
• Part III: the gain you must report now because you received cash or other property that is not real estate (called boot), and your basis in the new property. Basis is the figure your depreciation and future gain are measured from, and it carries over from the old property with adjustments.

Report any taxable gain on Schedule D or Form 4797, as the instructions direct. If you made more than one exchange in the year, you can file one summary Form 8824 with an attached statement for each exchange.

If the sale closed late in the year and the purchase will not close before April 15, request an extension with Form 4868 by the April due date. The extension moves your filing deadline to October 15 and keeps the full 180 days available. It does not extend the time to pay any tax you owe.

What makes an exchange fail or become partly taxable?

• Touching the money. The IRS warns that taking control of cash or other proceeds before the exchange is complete may disqualify the whole transaction and make all of the gain taxable.
• Missing a deadline. The IRS says the 45-day and 180-day limits cannot be extended for hardship. The only exception is disaster relief the IRS announces for a specific disaster.
• Buying something you did not identify. The property you receive must be substantially the same as a property on your notice, unless you bought it within the first 45 days.
• Leftover cash or debt relief (partly taxable). Money the QI returns to you after the purchase, and old mortgage debt not replaced by new debt or added cash, is boot. Boot does not cancel the exchange. You are taxed on your gain up to the amount of boot, never more than your total gain, and the rest stays deferred. Boot in a 1031 exchange shows how to size the purchase to avoid it.
• A failed intermediary. If you miss the timing rules because of the QI, the exchange does not qualify. When a QI defaults because of bankruptcy or receivership, Revenue Procedure 2010-14 lets you, if you meet its requirements, report the gain in the years you recover payments rather than all at once.