1031 Tax Exchange

Published On: April 19, 2009

Save money with a 1031
How would you like to save thousands and not pay Capital Gain Taxes on the sale of Real Estate?   If you answered "YES", then contact us about our "FREE" 1031 Tax Exchange Seminars.

What is a "1031 Exchange" aka "Like Kind Property Exchange"?
Sometimes referred to as a "Starker Trust", a 1031 Exchange is a transaction in which an owner of property held for investment is allowed to sell one or more properties and purchase one or more properties without a tax consequence. It is the best strategy for the deferral of capital gains tax that would ordinarily arise from the sale of Real Estate. Real Estate owners can accomplish almost any investment objective with 1031 Exchanges including greater leverage, diversification, improved cash flow, geographic relocation, and/or property consolidation.

How does an Exchange work
An Exchange is usually a 3 way Exchange in which an intermediary is used to facilitate the transaction. Four things ordinarily occur in an exchange:

  • The seller sells the relinquished property.
  • At closing the sale proceeds go to a Qualified Intermediary where the funds are held in a trust account "For Benefit Of" the exchanger.
  • The seller identifies replacement properties within 45 days of the closing of the relinquished property.
  • The seller (now the buyer) closes on the replacement property(ies) within 180 days of closing on the relinquished roperty and the funds are wired from the "FBO trust account" by the intermediary to the closing agent.

    Why would I want to be involved in an Exchange?
    Do you own "management intensive" Real Estate? Or perhaps you own property you purchased or inherited years ago and would prefer another property. You have probably realized good returns on investment that will otherwise be lost to the IRS. The sale of every property is a potential tax event with the tax consequence being realized after the closing of the property. Section 1031 was written into the Internal Revenue Code in the 1920's. The IRS realizes that your investment in Real Estate spurs the economy onward, however upon the sale of the property, any profit realized from appreciation must be reported, and is taxed at 20%. The depreciation you have been enjoying will be taxed at 25%. If you own passive investment property (raw land for example) you may have enough profit to invest to generate a cash flow by purchasing an income producing property.

    What qualifies as "Like Kind" Property?
    You can exchange any Real Estate investment for any other type of Real Estate investment - for example, vacant land can be exchanged for a warehouse, an office building for an apartment complex, or a vacation home, an orange grove, a golf course, horse ranch, whatever. As long as the property being sold is not a primary residence, and there is a tax liability to selling, an Exchange should be considered.

     

    DO'S AND DON'TS of 1031 Tax Deferred Exchanges

    Do plan in advance for the exchange. The Qualified Intermediary cannot have a fiduciary relationship with the exchanger; therefore the QI cannot give legal or tax advice. The QI does consult with the exchanger, as well as the exchanger's CPA, accountant, attorney, broker, financial planner, and lender.

    Do attempt to sell before you purchase. Occasionally exchangers find the ideal replacement property before the relinquished property is sold. In this situation a "Reverse Exchange" may be necessary. We are happy to discuss Reverse, Build To Suit, and Improvement Exchanges. 

    Do remember these basic rules. To qualify for a complete tax deferral use all proceeds from the relinquished property to purchase the replacement property. Make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property. An exception occurs when a reduction in equity cannot be offset by increasing debt. And finally, receive on Like Kind" property. Real Estate cannot be exchanged for jewelry, stocks, mutual funds, etc.

    Don't plan to sell and invest the funds in property you already own. Funds applied toward property already owned are considered "Goods and Services", not "Like Kind" properties.

    Don't change the manner of holding title during the exchange, or dissolve partnerships. A change in the exchanger's legal relationship to the property will jeopardize the Exchange. Maintaining "Continuity of Title" is critical to the Exchange.

    Don't miss the identification period (45 days) or the closing date (180 days). A reputable Qualified Intermediary will not act on back dated information or late identifications, and the IRS is unforgiving on such matters.

    Do contact Real Estate Exchange Services regarding trusts, corporations, partnerships, option money, seller financing, personal property included in the sale, farm and ranch property, multiple units with one side owner occupied.

    Remember! Exchanges must be reported in the tax year that the relinquished property was closed, regardless of the tax year the acquisition property was closed.

    The Internal Revenue Code Section 1031 is only one page in the total code, however the Rules and Regulations are more than 65 pages with hundreds of Private Letter Rulings. As members of the Federation of Exchange

    Accommodators it is Real Estate Exchange Services, Inc.'s responsibility to counsel with the exchanger, structure the exchange, prepare the documentation, coordinate the closing (for the exchange portion of the transaction) and maintain preparation for IRS audit.