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1031 Exchange on Cape Cod Explained

In the simplest of terms, a 1031 Exchange is at tax deferral that permits the taxpayer to reinvest the proceeds from the sale of property held for investment or business purposes into another investment or business property, while deferring the capital gains that would normally be due on the initial sale.

For instance, if you have own a house on Cape Cod that you have used as a summer rental for the last 5 years and decide to sell, you may avoid paying the capital gains on the sale, as long as you, through the 1031 Exchange process, buy another property that you plan on using for investment or business purposes.

Basic Steps

Step 1: Sell! – start the 1031 process before the sale though. Find a qualified exchange specialist to guide you through the process.
Step 2: You must identify the replacement property that you want to purchase within 45 days of the sale of the relinquished property. The money from the sale must be held by a qualified intermediary.
Step 3: Purchase the replacement property or business within 180 days of the sale of the relinquished property. The property must be of equal or greater value.

This is obviously a simplified outline of the process, but gives you the basic idea of using the 1031 Exchange on Cape Cod.

Here are the 7 Basic Rules:

1. Intent: The property must be held for investment or productive use in a trade or business.
2. Holding Time: There is no specific period of holding time to determine the intent. In some cases, a period of more than one year has been accepted, but time periods may be subject to review.
3. Like-Kind: The replacement property must be of “like kind”. “Like kind” can include any of the following: raw land, single family rental, an office building, motel, a ranch or farm, apartment building, duplex or even a 30 year lease. The replacement property can be anyone of those. It does not have to be the exact type of investment or business property as you sold.
4. Equal or Greater Amount: The replacement property must be of equal or greater amount. All cash proceeds must be used to purchase the replacement property or properties.
5. Timeframe: The replacement property must be identified within 45 days and purchased within 180 days of the sale of the relinquished property.
6. Identification Rules: Three replacement properties may be identified by the investor without regard to their value. Or the investor may identify more than three properties as long as their value does not exceed 200% of the relinquished properties value. Or the investor may identify an number of properties provided the investor acquires 95% of the fair market value of those properties.
7. Qualified Intermediary: The proceeds of the relinquished property must be held by a qualified, independent party and not an agent of the investor.

Many people have vacation homes on Cape Cod, so how can the 1031 Exchange process be used to buy or sell one? The principal of Safe Harbor, which is effective for exchanges occurring on or after March 10, 2008, can be utilized for exchanges of vacation homes and conversions to or from a personal residence.

How does a Taxpayer meet Safe Harbor for a vacation home or principal residence you ask?
1: The amount of use by the taxpayer (or related parties) must be limited to 14 days or 10% of the rental period (if greater) for the two years prior to the exchange.
2: The property must be rented to an unrelated party for at least 14 days per year. If it is a related party it must be rented as a principal residence at fair market value

Using 1031 to Buy your Cape Cod Dream Home
1: Sell your rental property on Cape Cod and start the 1031 process.
2: Buy your dream home with the intention to rent it for one or two years. There is no stated time period within the 1031 rules, but your tax advisor should be consulted to determine how long they think you should hold it as a rental until moving into as a primary residence.