About 1031 Exchanges
Leverage Oil & Gas Assets in 1031 Like Kind Exchanges
Visit our 1031 Exchanges page to learn about Accruit, EnergyNet's 1031 Exchange partner, and request to be contacted.
What is a 1031 Like-Kind Exchange?
A 1031 Like-Kind Exchange, also known as a Like-Kind Exchange, LKE or 1031 Exchange, allows companies to sell a depreciated asset and defer recognition of any gain (and therefore the associated tax bill) when the proceeds of the sale are used to purchase a replacement asset of similar (or "like kind") classification. Depending on combined state and federal tax rates, the taxable gain can approach or even exceed 40% of the price of the sale, so the cash flow benefit to the exchanging company can be substantial.
LKEs have been a part of the tax code since 1921, and the rules governing them have been updated a number of times.
As with any tax regulation, there are strict rules that must be followed. In order to properly structure a 1031 exchange:
- Assets exchanged must be of like-kind. This status is determined through either General Asset Class (GAC) (http://www.1031exchange.com/general-asset-class.php) or North American Industry Classification System (NAICS) (http://www.census.gov/eos/www/naics/).
- A Qualified Intermediary (QI) is most often required to hold sales proceeds until replacement assets are purchased.
- The exchange must occur within a prescribed timeline.
- The exchange must be established in advance of the sale.
What Kinds of Assets are Eligible for 1031 Exchange Treatment?
The most commonly exchanged asset types are real estate, and the tax code dictates that all real estate is like-kind with all other real estate. Therefore, you could exchange a warehouse for a golf course, an apartment building for an Oil & Gas property or a strip mall for vacant land.
The law also allows for the exchange of tangible assets, as well as some intangibles. O&G enterprises typically buy and sell a wide range of eligible assets, including but not limited to:
- Rock drills
- Casing, oil and gas field-type
- Tubing, oil and gas field-type
- Oil and gas field-type drilling machinery and equipment (except offshore floating platforms)
- Drilling equipment
- Drilling rigs
- Bits, oil and gas field-type
- Gas well machinery
- Water well machinery
- Well logging equipment
- Derricks, oil and gas field-type
- Vehicles (trucks, trailers, etc.)
- Mineral rights
Other asset types include:
- Agricultural equipment
- Automobile fleets
- Collectibles (like art, coins, vintage cars, wine, etc.)
- Construction equipment
- Race horses and livestock
- Manufacturing equipment
- Boats and marine equipment
- Medical equipment
- Mining equipment
- Telecom/IT equipment
- Utility infrastructure
Types of 1031 Exchange
Tax law allows several kinds of LKE.
Simultaneous Exchange: In a simultaneous exchange the relinquished property and the replacement property transfer concurrently. This process isn't as simple as transferring the relinquished property and acquiring the replacement asset on the same day. To avoid the risk of the exchange being deemed a taxable sale by the IRS, it's important to involve a Qualified Intermediary (QI).
Forward Delayed Exchange: The sale of the relinquished asset and purchase of the replacement property don't need to occur at the same time. The exchanger first sells the relinquished property and then acquires the replacement property within 180 days of the sale. If the replacement property is not purchased within 45 days of the sale of the relinquished property, the exchanger must identify the replacement property by midnight of the 45th day.
Reverse Exchange: An exchanger may not be able to sell the relinquished property before purchasing the replacement asset. In these cases, the exchanger can structure the transaction as a reverse exchange. Reverses are more complex than simultaneous or forward exchanges and require an Exchange Accommodation Titleholder (EAT) to take ownership to either the relinquished or replacement asset until the relinquished asset is ultimately sold to a buyer.
Improvement Exchange: An exchanger can purchase replacement property and use some of the proceeds to make improvements to the asset as long as the exchange is structured as a "build-to-suit" or improvement exchange. This process is often used to renovate an existing building or to construct a new building on vacant land; it can also be employed for upgrades to many kinds of tangible assets. Like the reverse, an improvement exchange is more complex and requires the EAT to take possession of the replacement property.
Program Exchange: Businesses with extensive asset portfolios (like leasing firms or heavy equipment dealers) often find it advantageous to conduct forward exchanges on an ongoing, programmatic basis. For these enterprises, repetitive exchange programs handle multiple assets and exchange transactions with significant documentation pursuant to a master Program Exchange Structure. Depending on a variety of factors, including size of portfolio and exchange volume, a business may be best served by either a self-service or full service program.
1031 Exchanges in the Modern Era
Historically, managing a 1031 Exchange was extremely labor-intensive and not economically feasible for low-value assets. However, with advanced technology, the old document-intensive process has been replaced with a technically efficient and cost-effective approach that maximizes the client's benefit while minimizing administrative headaches and the risk associated with cumbersome paper-based processes.
1031 Exchanges are complex transactions with associated risks involved. Before contemplating participation in a 1031 Exchange, you should always consult with your tax advisor, attorney, and financial services professional to discuss the potential risks involved in these types of investments in order to determine if such an Exchange is appropriate and suitable based upon your individual needs and circumstances.
Frequently Asked Questions about 1031 Exchanges
Are 1031 exchanges tax free?
No. It's not tax free. However, if you develop a strong, long-range asset management plan and continually replace the assets purchased through an LKE, you can potentially defer these taxes indefinitely.
Why would I want to exchange vs. sell and simply pay taxes?
By deferring your taxes, you retain your cash (potentially up to or exceeding 40% of the sale price) which can then be invested in new assets (real estate, construction equipment, etc.).
What do I need to do in order to execute an exchange?
You need to work through a Qualified Intermediary (QI). Accruit offers QI (Qualified Intermediary) services as a 3rd party service unrelated to EnergyNet.com's services. Under a written exchange agreement with the exchanger, the QI acquires the relinquished property or asset and transfers it to a buyer. The QI holds the cash, as required by the Internal Revenue Code. Finally, the QI acquires the replacement property or asset and transfers it to the taxpayer, completing the exchange.
Why do I need a Qualified Intermediary? Can't I just keep my own cash and do the exchange?
No. IRC regulations are clear. The taxpayer must not receive or have constructive receipt of the proceeds in any way. It will disqualify the exchange.
Does the Qualified Intermediary actually take title to property or assets?
Not in most situations. Property can be deeded or licensed between the parties as you would in a normal sales transaction.
What are the time restrictions on an exchange?
A taxpayer has 45 days after the date the property or asset is transferred to a buyer to purchase or identify replacement property. If the taxpayer makes this identification, the timeline is extended by 135 days or until the tax filing for that year. This brings the total timeline to 180 days, or six months.
Is there a limit to the number of exchanges that can be done?
No. Generally you can exchange as many properties or assets as you want, but there are strict deadlines to follow in order to maximize your exchanges (you have a full 180 days to complete the exchange). Section 1031 Exchanges can continue repetitively for as long as the taxpayer continues to buy and sell "like kind" assets. It's this rolling of exchanges that maximizes cash flow benefit and creates an indefinite deferral.
How do I learn more?
Visit our 1031 Exchanges page and request a contact from Accruit. You'll be contacted within one business day!