Glossary of 1031 Exchange Terminologies
Carl E. Sera, CMT
June 1, 2021
1031 - Section of the Internal Revenue Code permitting Tax Deferred Exchanges of like-kind property of both real and personal, held for investment or income producing purposes.
1031 Exchange - The act of exchanging relinquished or acquired real estate or personal property, which is held for investment or income producing purposes. All exchanges must be compliant with the Internal Revenue Code 1031 for use of deferring taxes.
Accommodator - An unrelated professional party who facilitates 1031 exchange transactions. Also known as Qualified Intermediary (Q.I.) or Facilitator.
Adjusted Basis - The original purchase price of the property being exchanged, plus capital improvements less any depreciation.
Basis - The original purchase price of the property to be exchanged.
Boot - Returned property or cash received by the Taxpayer not included in the exchange. Boot is taxable.
Build-to-Suit Exchange - Also known as Construction Exchange or Improvement Exchange. Permits the Taxpayer to utilize exchange proceeds to improve the replacement property before the exchange is complete. Strict structuring is necessary to prevent transfer of ownership before the improvements are completed.
Capital Asset: Any property owned by an owner used in a trade or business or held for investment specifically real property.
Capital Gain or Loss: The difference between the selling price of a piece of real estate and its Adjusted Cost Basis.
Capital Gain Tax: Tax levied by Federal and state governments on investments that are held for one year or more. Investments may include real estate, stocks, bonds, collectibles and tangible depreciable personal property. However, real estate is the only investment that can be exchanged.
Capital Improvements: For land or buildings, improvements (also known as capital improvements) are the expenses of permanently upgrading your property rather than maintaining or repairing it. Instead of taking a deduction for the cost of improvements in the year paid, you add the cost of the improvements to the basis of the property. If the property you improved is a building that is being depreciated, you must depreciate the improvements over the same useful life as the building.
Closing Costs: Costs paid at the closing for the relinquished or replacement properties.
Constructive Receipt: Refers to the owner having unrestricted control of the proceeds from the relinquished property. Constructive receipt of proceeds by an owner will invalidate a 1031 exchange.
Delayed Exchange: Also known as Deferred Exchange, Forward Exchange and Starker Exchange. When an exchange is not simultaneous and properties are relinquished and acquired at separate times during the exchange time period.
Depreciation: The loss of value to both personal and real property over time of ownership. The depreciation is used to help find the adjusted basis figures.
Disposition: The sale or other disposal of property that causes a gain or a loss including like-kind exchanges and involuntary conversions.
Depreciation Recapture: The amount of gain resulting from the disposition of property that represents the recovery of depreciation expense that has been previously deducted on the Taxpayer's (Exchanger's) income tax returns.
EAT (Exchange Accommodation Titleholder): The unrelated party that takes title to either the relinquished property or the replacement property in an exchange under Rev. Proc. 2000-37.
Equity: The value of a person's ownership in real property or securities; the market value of a property or business, less any claims or liens on it.
Exchange Agreement: A written agreement between the Qualified Intermediary and Exchanger setting forth the Exchanger's intent to exchange relinquished property for replacement property, as well as the terms, conditions and responsibilities of each party pursuant to the tax-deferred, like-kind exchange transaction.
Exchange Expenses: Expenses related to the exchange or sale of property.
Exchange Period: The period of time during which the Exchanger must complete the acquisition of the replacement property(ies) in his or her tax-deferred, like-kind exchange transaction. The exchange period is 180 calendar days from the transfer of the Exchanger's first relinquished property, or the due date (including extensions) of the Exchanger's income tax return for the year in which the tax-deferred, like-kind exchange transaction took place, whichever is earlier, and is not extended due to holidays or weekends.
Exchangor/Exchanger: The Taxpayer who is completing the tax-deferred, like-kind exchange transaction. An Exchanger may be an individual, partnership, LLC, corporation, institution or business.
Fair Market Value: The price at which property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts.
Fractional Interest: An undivided fractional interest or partial interest in property. See also Tenancy-In-Common Interests.
Gain: The difference between the adjusted basis in the property and the gross selling price, less direct selling expenses.
Held for Business: Assets that are used in the operation of a business.
Held for Investment: Assets that are purchased and held for appreciation.
Identification Period: The period of time during which the Exchanger must identify potential replacement properties in his or her tax-deferred, like-kind exchange. The period is 45 calendar days from the transfer of the Exchanger's relinquished property and is not extended due to holidays or weekends.
Intermediary: An unrelated party (All States 1031) who participates in the tax-deferred, like-kind exchange to facilitate the disposition of the Exchanger's relinquished property and the acquisition of the Exchanger's replacement property. The Intermediary has no economic interest except for any compensation (exchange fee) it may receive for acting as an Intermediary in facilitating the exchange as defined in Section 1031 of the Internal Revenue Code. The Intermediary is technically referred to as the Qualified Intermediary (QI), but is also known as the Accommodator, Facilitator or Intermediary.
Like-Kind Exchange: The sale or disposition of real estate or personal property (relinquished property) and the acquisition of like-kind real estate or personal property (replacement property) structured as a tax-deferred, like-kind exchange transaction pursuant to Section 1031 of the Internal Revenue Code and Section 1.1031 of the Treasury Regulations in order to defer Federal, and in most cases state, capital gain and depreciation recapture taxes.
Like-Kind Property: Property that is exchangeable with another property. Refers to the nature or character of the property and not to its grade or quality. Real estate is like-kind to real estate.
Limited Liability Company (LLC): Members of Limited Liability companies enjoy the limited liability offered by corporations and the minimum requirements of an S corporation. Limited Liability Companies typically contain two or more members and must file articles of organization with the secretary of state, although single member LLCs are allowed in certain states.
Partial Exchange: When an exchange entails receiving cash, excluded property and/or non-like-kind property and/or any net reduction in debt (mortgage relief) on the replacement property as well as an exchange of qualified, like-kind property. In the case of a partial exchange, tax liability would be incurred on the non-qualifying portion and capital gain deferred on the qualifying portion under INTERNAL REVENUE CODE Section 1031.
Qualified Escrow Account: An escrow account, wherein the Escrow Agent (Strategic Property Exchanges/All States 1031) is not the Exchanger or a disqualified person and that limits the Exchanger's rights to receive, pledge, borrow or otherwise obtain the benefits of the tax-deferred, like-kind exchange cash balance and/or other assets from the sale of the relinquished property in compliance with the Treasury Regulations. The Qualified Escrow Account also ensures that the Exchanger's exchange funds and/or assets are held as fiduciary funds and are therefore protected against claims from potential creditors of the Qualified Intermediary.
Qualified Intermediary (QI): An unrelated party (All States 1031) who participates in the tax-deferred, like-kind exchange to facilitate the disposition of the Exchanger's relinquished property and the acquisition of the Exchanger's replacement property. The Qualified Intermediary has no economic interest except for any compensation (exchange fee) it may receive for facilitating the exchange as defined in Section 1031 of the Internal Revenue Code. The Qualified Intermediary is the correct technical reference pursuant to the Treasury Regulations, but the Qualified Intermediary is also known as the Accommodator, Facilitator or Intermediary.
Real Property: Any type of real estate is like-kind to other real estate. Real property is all considered within one class of assets.
Related Person/Party: Any person bearing a relationship to the Exchanger as described in Section 267(b) of the Internal Revenue Code. Related parties include family members (spouses, children, siblings, parents or grandparents but not aunts, uncles, cousins or ex-spouses) and a corporation in which you have more than a 50% ownership; or a partnership or two partnership in which you directly or indirectly own more a 50% share of the capital or profits.
Relinquished Property: The property the owner will be selling in the exchange.
Replacement Property: The property to be received by the owner in the exchange.
Reverse Exchange: An exchange that occurs in reverse order of a forward exchange, as the replacement property is bought and held by the EAT and then the relinquished property is sold - OR - taxpayer can transfer title to the relinquished property to the EAT and simultaneously acquire the replacement property.
Safe Harbors: The Treasury Regulations provide certain Safe Harbors that assist Qualified Intermediaries and Exchangers in structuring tax-deferred, like-kind exchange transactions so they can be assured that no constructive receipt issues will be encountered during the exchange cycle.
Seller Carry-Back Financing: When the buyer of a property gives the seller of the property a note, secured by a deed of trust or mortgage. In a Section 1031 Exchange, seller carry-back financing is treated as boot, unless it is sold at a discount on the secondary market or assigned to the seller as a down payment on the replacement property.
Straight-line Depreciation Method: A depreciation method that spreads the cost or other basis of property evenly over its estimated useful life.
Tax-Deferral: The postponement of taxes to a later year, usually by recognizing income or a gain at a later time. Tax-deferred, like-kind exchange transactions are a common method of deferring capital gain and depreciation recapture taxes.
Taxpayer: The person or entity that is completing the tax-deferred, like-kind exchange transaction, commonly referred to as Exchanger.