In short
Five questions anchor our first call: your deadline, your debt, your state, your income needs and your heirs. Each maps to a rule that shapes the exchange.
Every exchange we work on starts with a conversation, and the first call follows five questions: where you are on the clock, what debt comes off at closing, which state the property is in and where you live, how much income you need from the replacement, and who inherits it. None of them is small talk. Each one maps to a specific rule in section 1031 or the regulations, and the answers decide which structures are open to you before any offering is discussed.
Where are you on the clock?
The first thing we need to know is whether the relinquished property has closed, is under contract, or is still being listed. Under Reg. section 1.1031(k)-1(b), the identification period “begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter,” and the exchange period ends at midnight on the earlier of the 180th day or the due date of your return. The clock does not wait for you to find an intermediary.
If the sale has already closed and the proceeds came to you, the exchange is usually over before it started: the qualified intermediary safe harbor requires a written exchange agreement that limits your rights “to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.” That is why we ask the question first, and why when the 45-day clock starts and is it too late to start are the two pages we send most often after a first call.
What debt comes off at closing?
A loan paid off at closing is treated as money you received. Reg. section 1.1031(d)-2 states that liabilities assumed by the other party, or liabilities to which the exchanged property is subject, are “treated as money received by the taxpayer upon the exchange,” and then nets them against liabilities you take on and cash you pay. Line 15 of Form 8824 does the same arithmetic (Instructions for Form 8824).
We ask for the payoff figure because it changes the structure. Someone with no debt can go into unleveraged offerings. Someone carrying a 60 percent loan needs replacement debt or outside cash, and that is where a cash out DST, a high-leverage zero cash flow structure, can cover the debt figure with a small portion of the proceeds, leaving the rest free for low-leverage investments. Whether you must replace the loan at all is answered in replace the mortgage or add cash.
Which state is the property in, and where do you live?
Section 1031 is federal. States follow it to different degrees, several withhold tax at closing unless you file an exemption form in time, and California keeps a claim on deferred gain even after you buy out of state. For taxable years beginning on or after January 1, 2014, a taxpayer who exchanges California real property for like-kind property outside California must file form FTB 3840 “for the taxable year of the exchange and for each subsequent taxable year, generally until the California sourced deferred gain or loss is recognized,” and if the form is not filed the Franchise Tax Board “may estimate net income and assess tax plus any applicable penalties and interest” (FTB 3840 instructions).
So we ask both the property’s state and your state of residence, and we check the state page for each. The closing-day forms are covered in state withholding at closing and the closing hub, and a DST that holds property in several states raises its own filing questions, set out in DST multi-state tax issues.
How much income do you need from the replacement?
The structures differ most here. A traditional DST holds stabilized, income-producing property with management in place; many sponsors pay monthly, distributions are prorated from your closing date, and they are never guaranteed. A cash out DST pays no current income, because operating income services the loan, with the return coming at disposition. A direct title security pays fixed monthly rent under a triple-net lease for the lease term. If you are retiring on this money, the answer rules some structures out; if you have other income and want liquidity, it rules others in. How reliable DST distributions are, and what can interrupt them, is covered in DST distributions timing and reliability.
Who inherits this?
Under 26 U.S.C. section 1014(a)(1), the basis of property acquired from a decedent is generally “the fair market value of the property at the date of the decedent’s death.” Gain deferred through one exchange after another is not taxed if the property is still held at death, and the heirs take the stepped-up basis. That changes the advice for an owner in their seventies with no intention of selling again, and it is why we ask about children, trusts and whether a surviving spouse will want to manage anything.
A DST interest fits this plan in a way a building often does not: it can be divided among heirs without a partition, and nobody inherits a management job. The mechanics are in DSTs in estate planning and the longer plan in swap till you drop.
Putting the five answers together, hypothetically and in round figures: the caller is closing in three weeks on a $1,500,000 sale with a $500,000 loan and a $400,000 adjusted basis, lives in Nevada, owns the building in California, needs $4,000 a month of income, and has two children. The deferred gain is roughly $1,100,000. The call produces a plan with four parts: an intermediary engaged before closing, $500,000 of debt to cover, a California FTB 3840 filing every year until the gain is recognized, and an income target that points toward stabilized offerings rather than a zero cash flow structure for the bulk of the equity. Run your own numbers with your CPA.
What to do now
- Write down your closing date, loan payoff, adjusted basis, the two states and your monthly income need before you call anyone.
- If the sale is under contract, confirm that an intermediary will be assigned into the contract before closing; see what the intermediary needs.
- Book the call and bring those five answers.
