2024 Indiana 1031 Exchange Guide
A 1031 exchange in Indiana is a valuable tax deferment tool that many of the most successful real estate investors in the country utilize especially in popular markets like Indianapolis, IN. This type of exchange can allow you to swap your high-maintenance properties for low-maintenance properties or move your investment properties to another state without any penalties or interference from the internal revenue code.
In this article, we’ll cover how Indiana 1031 exchanges work and what the pros and cons are for Indiana real estate investors.
What is a Relinquished Property
The relinquished property is the one that you are selling or exchanging in the §1031 exchange.
What is a Replacement Property
The replacement property is the one that you are acquiring in the Indiana §1031 exchange. You can choose to have more than one replacement property as part of your §1031 exchange, so long as their values add up to no more than 200% of value of the relinquished property value.
Please note that the replacement properties’ values will have no effect on the qualification of tax-deferred treatment under §1031 exchange rules. You may identify no more than three like-kind properties replacement properties. This is known as the “three property rule” which is discussed further below.
Types of 1031 Exchanges in Indiana
There are four main types of Indiana 1031 exchanges. If you wish to learn more about each, we recommend reading our Complete 1031 Guide for Real Estate Investors.
Simultaneous Exchange
A simultaneous §1031 exchange occurs when the sales of the relinquished property (the one you are selling) and the replacement property (the one you are buying) close at the exact same time. Even the slightest delay, such as one caused by sending the money through an escrow company, can disqualify the exchange. This means you will have to immediately pay any applicable federal and state income tax on the sale of your relinquished property.
Delayed Exchange
Delayed §1031 exchanges are far more popular, because they allow you to sell your relinquished property and then identify and purchase the replacement property at a later date within a certain period of time. In the meantime, a qualified intermediary will hold the proceeds from the sale of your relinquished property in trust. Timelines must be adhered to, as we’ll cover in the next section.
Reverse Exchange
Reverse exchanges are essentially the opposite of delayed exchanges: you purchase the replacement property first and then sell your relinquished property at a later date. This type of exchange is complex and requires careful planning, since the replacement property must be purchased with cash and many banks do not offer loans for this type of §1031exchange.
Construction or Improvement Exchange
Construction or Improvement type of exchange allows you to use the equity from the sale of your relinquished property to make improvements on the replacement property while a qualified intermediary holds the deed.
Certain rules apply with respect to what can be done to the property, and all improvements and construction must be completed before the intermediary hands over the title to you. It is also important to note the ‘Napkin Test’ could apply to improvement §1031 exchanges.
Indiana 1031 Exchange Rules
There are several important rules for 1031 exchanges:
Like-Kind Exchange Properties
In order to be eligible for an like-kind exchange, properties must be for business or investment purposes (personal property such as your primary residence or a vacation home are not eligible) and they must be like-kind. The words “like kind” refer to the nature or character of the property and not to its grade or quality.
This broadly means that they must be similar in nature, class, or character – raw land, apartment properties, single-family home rental properties, and business office rental properties are all considered like-kind with one another. In addition, due to the December 2017 Tax Cuts and Jobs Act, any §1031 exchange property is limited to like-kind “real property” that is held for productive use in a trade or business.
Timing Rules
closing) of your relinquished property to identify a qualifying replacement property, and 180 days from that same date to complete the purchase of the replacement property. Unless your tax return is due before 180 days have elapsed, in which case you must complete the purchase before submitting your tax return.
This is important to be aware of, especially if your 180-days falls on certain federal and state income tax return original or extended due dates. It’s important to plan your §1031 in advance to avoid being rushed and/or being forced into a suboptimal trade.
The 45-Day Identification Rule
Within 45-days of closing the sale, you must identify the replacement property (or multiple properties) via written notice to your qualified intermediary. The closing date does not count as one of the 45 days. If the closing falls on a weekend or holiday, we recommend that you write your notice to your intermediary a few business days before the true end date (ideally sooner).
The 180-Day Closing Period Rule
Within 180 days of closing the sale on your relinquished property, you must close, fund, and acquire the replacement property. Same as the 45-day rule, we recommend writing the written notice a few business days before the true end date.
Please remember that both the 45-day identification period and the 180-day closing period do not happen after one another. Their start dates begin the day after the sale of the relinquished property.
Certain rules apply with respect to what can be done to the property, and all improvements and construction must be completed before the intermediary hands over the title to you. It is also important to note the ‘Napkin Test’ could apply to improvement §1031 exchanges.
Exception to the 180-Day Rule
There is an exception to the 180-day rule.Ordinarily you would have nearly 6 months to complete the exchange. However if you close the sale of the relinquished property on December 1 you would only have 3.5 to 4.5 months to complete it because federal income tax returns are due on March 15 or April 15. This also depends on the tax classification of the entity completing the §1031 exchange.
You may. If this happens to occur in your situation, if applicable, we recommend filing for an extension of time to file your federal and state income tax returns to receive the full 180 days.
The Three Property Rule
If you designate more than three properties as potential replacement properties, the aggregate amount of all the properties’ fair market values must not exceed more than two times, or 200%, the gross sales price of the relinquished property. The three property rule does not apply if three or less properties are identified as replacement properties.
Direct Deeding
Historically, the deeding process for a 1031 exchange was cumbersome. Now, the process is more streamlined so you can deed the relinquished property directly to the buyer and the seller of the replacement property can deed it directly to you.
Exchange Proceeds
To avoid constructive receipt issues, the money from selling your relinquished property will be received on your behalf by a qualified intermediary and directed to the seller after selecting your replacement property. To avoid not paying any tax, all the proceeds of the sale are used to purchase the replacement property.
If the replacement property costs less than what you sold your relinquished property for, you will have to pay tax on the difference, also called “boot”.
Intermediary Rule
During the 180-day period of a §1031 exchange, you cannot have access to the money you acquired by selling your relinquished property. Therefore, you must hire a qualified intermediary who is not related to you in any way to hold the funds in a designated account until they can be directed to the purchase of the replacement property.
Title Rule
This rule basically requires that your name must be listed exactly the same on the replacement property title as it was on the relinquished property title to ensure that no shady business is going on. The same goes for trusts and corporations, and in fact, if you are married and have your spouse’s name on the relinquished property title, your spouse’s name must also go on the replacement property title.
Greater or Equal Value Rule
To completely defer the federal and state income tax that would normally be incurred with the sale of an investment property, the net market value of the replacement property must be equal to or greater than that of the relinquished property.
You can select more than one replacement property, so long as their combined total cost exceeds the price of your relinquished property, but is not more than 200% of the relinquished property cost.
This is known as the ‘200% rule’ within the meaning of Treas. Reg. §1.1031. It should also be noted that the replacement properties’ values will have no effect on the qualification of tax-deferred treatment under §1031 if no more than three like-kind properties are identified as replacement property.
However, you can perform a partial 1031 exchange, where the replacement property is of lesser value, but then you will pay federal and state income tax on the difference (also called the “boot”). This is a perfectly viable option if you want to make some money out of the deal, but you must be prepared to pay tax on the boot immediately.
Pros of an Indiana 1031 Exchange
There are many reasons that 1031 exchanges are excellent options for Indiana investors, including:
Tax Deferral
Obviously, deferral of federal and state income tax is the main benefit here. Keep in mind; however, that it is only a deferral and you will eventually have to pay the applicable tax once you eventually sell the exchanged property(ies) in a taxable sale. But, you can perform as many §1031 tax deferred exchanges as you want and thereby change and/or move your investment properties an unlimited number of times before ultimately paying the tax
Estate Planning
Although slightly morbid, you can actually defer paying the tax until your death. Then, if your heirs inherit the property, its value will be stepped up to fair market price and the heirs basis in the property will be equal to fair market value.
Putting this another way, if the heir were to sell the property immediately after inheriting it, there is a good possibility there would be no gain and thus no federal or state income tax as a result of the sale. That way, you can pass along the property to your heirs without saddling them with a potential large federal and state income tax liability upon the sale of the property.
Asset Accumulation
As mentioned above, there are no limits on the number of 1031 exchanges you can perform, which means you can exchange for progressively larger and more valuable properties over time without paying federal or state income tax if exchanged properly, allowing you to build your wealth. You can also diversify your investment portfolio quite broadly thanks to the loose like-kind requirements.
Cons of an Indiana 1031 Exchange
However, there are some negatives to take into account:
Strict Regulations
As we’ve outlined, there are many rules and regulations surrounding Indiana §1031 exchanges. If done improperly, the whole exchange can be disqualified and you will be immediately responsible for paying the federal and state income tax on your relinquished property. This could also lead to penalties from the IRS.
Reduced Basis for Depreciation
Although slightly morbid, you can actually defer paying the tax until your death. Then, if your heirs inherit the property, its value will be stepped up to fair market price and the heirs basis in the property will be equal to fair market value.
Putting this another way, if the heir were to sell the property immediately after inheriting it, there is a good possibility there would be no gain and thus no federal or state income tax as a result of the sale. That way, you can pass along the property to your heirs without saddling them with a potential large federal and state income tax liability upon the sale of the property.
Not Tax-Free
Once again, this is simply a tax-deferral strategy, not tax evasion, so you will eventually have to pay the capital gains tax. Unless, of course, you leave the property to an heir after your death, in which case they will be exempt from paying the deferred tax. However, in most cases, you will eventually want to sell your investment property to reap the financial benefits, and at that time, you will be responsible for paying the applicable taxes.
Asset Accumulation
With a §1031 exchange, the amount of depreciation that can be claimed on a replacement property is based on the adjusted basis of the relinquished property at the time the exchange is completed. Which means it will generally be lower than if you had purchased the replacement property for fair market value without using a §1031 exchange.
Finding the Right 1031 Exchange Company in Indiana
At TFS Properties, we specialize in 1031 exchanges and want to do everything we can to help you successfully navigate your own exchange. Although our service area only includes the greater Los Angeles area, we have a trusted nationwide network of reputable 1031 exchange companies and we will be more than happy to pass along a recommendation for one near you.
The information contained within this article is not intended to be construed as written legal advice. To the extent, you need assistance or guidance on any information contained within this article please consult your tax advisor.
