Frequently Asked Questions

Minnesota 1031 Exchange Process & FAQs

Let’s start with the basics. What is a 1031 Exchange? A 1031 Exchange is a simple transaction that allows you to differ the taxes on the sale of investment real estate by purchasing like kind investment real estate in a specific time frame. Simply put: a sale, plus a purchase, equals a tax deferral.

For us to start the exchange process, I simply need a copy of the contract and title commitment for the property being sold. Once you have a contract, please feel free to reach out to me to discuss your specific deal. An exchange must be opened prior to the closing of the sale. There is no way to retroactively save an exchange if this does not occur.

There are a few rules you have to follow in order to have a successful exchange in MN.

1. In order to get the full benefit of the deferral there are two rules you have to follow. One: you must purchase property that is equal to or greater in value to what you’re selling based off the contract sales price. And two: you must use all of the proceeds from that sale towards your purchase first.
   • For example: I’m selling some Minnesota property for $1M. Let’s say there is a 300k loan on the property. That loan would be paid at closing and the 700k would be wired to the exchange account. The rules say I must purchase a million-dollar asset and use the 700k in equity first. Whether I chose to get another 300k loan, or throw in 300k in cash, or do a combination of the two…it is completely up to me.
   • There is a misconception that it is all or nothing when doing a 1031 Exchange, however that is not true. A Partial Exchange is absolutely possible. For example:  You’re selling your property and all of your money is tied up in the property, so you need to take $100k at closing. You can do that, but those funds will be taxable to you dollar-for-dollar as profit. Similarly, if you’re selling for $1M and buying for $900k, that $100k shortfall is taxable to you dollar-for-dollar as profit.
2. The IRS requires that you maintain taxpayer continuity. Simply put, the taxpayer that is selling the property must be the same taxpayer that is purchasing the Replacement Property.
   • For example, I own a building in my personal name that I am selling in a 1031 Exchange. I have a few options as to how purchase my Replacement Property. I can, of course, purchase in my personal name to complete my exchange. Or I can purchase in a single-member LLC, of which I am the sole member, or a Revocable Trust of which I am the trustee. All of the entities I mentioned are seen as pass through entities for tax purposes. Although the title holder is different, the underlying taxpayer is the same.
3. The property in your exchange must be “like kind” to one another. All investment real estate is like kind to other investment real estate. You can sell residential property and buy commercial; sell commercial and buy farmland; sell farmland and buy industrial property. When it comes to transactions outside of the US, it has to be another piece of foreign land. Foreign for foreign; domestic for domestic.
4. There are two time periods you need to be aware of: you’ll have 45 days to identify potential Replacement Property and 180 days to close. The clock starts ticking for both from the closing of your sale. Keep in mind you can only purchase what you’ve identified within the 45-day period. The identification has to be specific and unambiguous and done in writing, signed by the taxpayer, and sent to us within the 45-day period. Within those 45 days, you do have some wiggle room. You can identify some property, revoke the identification and identify something else. But once the 45th day hits, you are locked into what you’ve identified.
   • Now, you couldn’t just hand us the phonebook as an identification – you are limited to the amount of properties you can identify.
   • The three-property rule allows you to identify up to three properties with no limitation on the aggregate value of said properties. I’m selling a property for a million dollars; I’ve identified 3 properties that add up to 3 million dollars. That is totally doable. Now if I identified 4 properties or more…then we fall into some specific rules we have to follow. Keeping with our example, if I identified 4 properties – the aggregate value of those 4 properties cannot exceed 200% of the value of the relinquished property. Ultimately, those 4 properties cannot exceed 2 million dollars. This is what they call the 200% rule. If they did exceed the 200% rule, then we now enter the 95% rule. The 95% rule states that you have to purchase at least 95% of what you’ve identified. So basically everything.
5. In order to successfully complete a 1031 Exchange, you have to go through a disinterested, third party known as a Qualified Intermediary or QI, which would be us at IPX1031. The reason why we are added to the transaction is because the IRS says if at any point the taxpayer has constructive receipt of the funds, those funds become taxable to them. So, our main role is to hold and safeguard your funds for the duration of the exchange. The fact that we are required to hold the proceeds from the sale is the main reason a 1031 Exchange must be set up before the closing.