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Home > 1031 Exchange
1031 Exchange
1031 Exchange Advantage
December Tip:(1031
Exchange Advantage, Inc.)
Open your exchange now and even if you cancel your exchange in the
New Year you still get to defer your taxes until 2009 as the
exchange is concluded (albeit cancelled) in 2008 and therefore taxes
are not due until the April 2009 reporting date!!!
Guidelines
Frequently Asked Questions
Exchange
Terminology
Glossary
- terms used in reference to 1031 exchanges
Newsletters
- full of excellent information from
Orexco
What is a Tax Deferred Exchange?
A tax deferred exchange is simply a method by which a
property owner trades one property for another without having to pay any
federal income taxes on the transaction. In an ordinary sale
transaction, the property owner is taxed on any gain realized by the
sale of the property. But in an exchange, the tax on the transaction is deferred
until some time in the future, usually when the newly acquired
property is sold
These exchanges are sometimes called "tax free
exchanges" because the exchange transaction itself is not taxed.
Tax deferred exchanges are authorized by Section 1031
of the Internal Revenue Code. The requirement of Section 1031 and other
sections must be carefully met, but when an exchange is done properly,
the tax on the transaction may be deferred.
In an exchange, a property owner simply disposes of
one property and acquires another property, rather than the sale of one
property and the purchase of another.
Today, a sale and a reinvestment in a replacement
property are converted into an exchange by means of an exchange
agreement and the services of a qualified intermediary - a fourth party
who helps to ensure that the exchange is structured properly.
The IRS' new regulations make exchanging easy,
inexpensive and safe.
Internal Revenue Code (IRC) Section 1031 is one of the
last remaining tax loopholes. It is a powerful tool that allows
investors to exchange any investment property for any other investment
property. For your exchange to be valid, you must follow specific IRS
regulations.
Here is an abbreviated list of the regulations.
1.) The properties being exchanged must be of a like
kind. For example, you may exchange:
- a house for another house (or several houses)
- a house for commercial real estate
- land for rental property
- a strip mall for an office building
- any investment property for any other investment
property (as long as it is not occupied as your primary residence)
2.) You must identify and close on your replacement
property within a specific period of time.
- You must identify the property (can identify 3 of
them) within 45 days of selling your other home (day of settlement)
- you may not use ANY of the proceeds from the
sold property or you will negate the exchange - not one penny
- You must settle on one of the three identified
properties within 180 days from day of settlement (do not count this by
months as some months have 31 days)
3.) 100% of the proceeds from your current property
must be held by a Qualified Intermediary and applied toward your
replacement property to get a full tax deferral.
4.) Your replacement property must be of equal or
greater value to the property you have sold to get a full tax deferral.
5.) Properties being exchanged must be used for
investment. Personal residences are not exchangeable.
Why
use a 1031 exchange:
To defer your
capital gains tax
To diversify
- Exchange one
property for a larger one.
- Exchange one
property for several properties.
- Increase
depreciation.
To simplify
- Exchange several
properties for fewer (or one) property.
- Improve the
quality of your property.
- Decrease
management responsibility.
To relocate
- Exchange for a
property closer to where you live.
- Exchange to an
area with higher appreciation.
Please consult your tax advisor
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Frequently Asked Questions
What is a tax deferred exchange?
When the proceeds from the sale of investment real estate are
used to purchase other Like-Kind investment real estate, you should consider a
tax deferred exchange. The use of an Accommodator or Qualified Intermediary
throughout your transaction is recognized as a Safe Harbor under IRS Regulations.
How can I qualify to pay NO taxes when I sell my property?
Any investor can qualify! Section 1031 of the IRS code lets
you sell your property and buy a new property without paying any taxes. You
simply follow specific rules.
What is a qualified intermediary?
The IRS says if you touch the money you pay the tax. However,
if you use a qualified intermediary
(or accommodator or facilitator)
to transfer the money from the sold property into the purchased property, you
qualify for a tax free exchange. The IRS does not permit your accountant,
attorney, or escrow company to be your qualified intermediary.
Can I get legal or tax advice from a qualified intermediary?
No, the IRS doesn't allow a qualified intermediary to give
legal or tax advice. However, they will work with your attorney and CPA to make
sure your tax free exchange goes smoothly.
Can I avoid paying taxes forever?
Yes, you can. By simply following the 1031 exchange rules
every time you sell one or more properties and buy replacement properties, when
you die your estate escapes all the capital gains taxes forever!
What exactly are the tax advantages in exchanging?
You can eliminate paying any capital gains taxes, and you can
eliminate paying the even higher-rate taxes on the recapture of depreciation
you've taken on your property. By exchanging into a higher priced property
you'll also gain additional depreciation deductions which can increase your
after-tax income.
Are there reasons to exchange other than tax advantages?
Yes, there are many non-tax reasons to exchange. For example,
if you no longer like managing property, you can exchange your management
intensive property for triple-net management free property, or exchange multiple
smaller properties for one that can be professionally managed. Or, say your
current property cannot be easily refinanced. You could exchange out of that
property for a new property which could be refinanced more easily so you can
take some cash out. Or, you might exchange to improve cash flow.
What kind of real estate qualifies for a 1031 exchange?
Almost every kind of real estate is considered "like kind" and
can be exchanged for any other real estate, including vacant land for
apartments, a rental house for a shopping center, an office building for a
leasehold interest with 30 years or more remaining, as long as you hold them for
investment or business use.
How long can I take to buy a new property?
To do a Delayed Exchange you
need to keep in mind that there are two very important time restrictions: the 45
day identification period and the 180 day exchange period. These time
restrictions are strictly enforced. There are neither exceptions nor extensions.
Once you have violated one of these time periods, your whole exchange fails.
You have 180 days between the closing date on the sold
property and the closing date on the purchased property. Do not think that this
is 6 months - COUNT THE DAYS ONLY
If the exchangor’s 45th or 180th day falls on
a weekend or holiday do I get the benefit of the following business day?
No. The IRS calculates this timeline based on calendar days.
There are no extensions given.
Can I buy a new property before selling my old one?
Yes, you can buy a new property before selling the old
property and still qualify - it's called a "reverse" exchange. The qualified
intermediary takes title to the new property you buy and holds it for you until
you sell your old property.
What are the requirements for deferring tax on
a capital gain?
In order to defer all of the tax on the sale of investment
property, first make sure that the relinquished and replacement
properties are “like kind” and held for productive use in a trade or business or
for investment. Second, make sure that the timelines for the exchange are
met. Third, make sure that all of the proceeds generated by the sale of
the relinquished property are used in the purchase of the replacement property
and that the FMV (fair market value) of the replacement property is equal to or
greater than sale price of the relinquished property. If any of the first two
requirements listed are not met, no exchange is possible. If any of the third
requirement is not met, a taxpayer may be able to partially defer their gain but
not wholly.
Can I get money out of the exchange tax free?
Yes, one way is to complete the exchange first and then
refinance the new property.
Can I use my IRA in conjunction with a 1031 Exchange?
Yes, if you do it right.
Using an IRA for real estate requires a special Self-Directed
IRA. Your Self-Directed IRA at Charles Schwab or Fidelity does NOT permit you to
hold real estate or any asset other than securities. This can be solved by
moving your IRA to a custodian that allows for real estate in the plan document.
With the right Self-Directed IRA (known as Real Estate IRA) and proper
structuring, you partner with your IRA to buy leveraged real estate. When it
comes time to sell, you can 1031 your portion of the gain while the IRA gets its
portion of the gains tax exempt.
For more information on how you can use an IRA to purchase
real estate please visit
www.MyRealEstateIRA.com
Can I buy more than one piece of property tax free?
Yes, you can acquire any number of replacement properties.
Can I exchange several smaller properties for a larger one?
Yes, you can sell any number of smaller properties and trade
up to a larger one.
How do I exchange into a larger property (trade up)?
You trade up by getting a bigger loan on the new property, or
adding cash, or equities in other properties, or notes carried back from the
sale of other properties, etc. Done right, it's all tax free.
Can I refinance without blowing the tax free exchange?
Yes, you can refinance the property you are selling before you
exchange, or refinance the property you are buying after you exchange, and the
proceeds are tax-free..... the timing and contract dates are critical.
Can I carry back a loan on the property I'm selling and still
have a tax free exchange?
Yes, the payments you receive are taxed as you get them, on an
installment sale basis. The balance of your equity is exchanged tax free.
I've already sold my property. Can I still do an exchange?
Yes, provided your sale has not closed yet, simply contact a
qualified intermediary and they will turn your taxable sale into a tax free
exchange with some simple paperwork. You can do this right up until the day
before closing.
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Terminology*
The real estate industry has its own unique language. When you
become involved in a real estate transaction, you may find yourself
a bit confused. When your transaction involves a Section 1031
exchange, the language can be even more befuddling. So, we have put
together this brief glossary to assist you. These terms may have
different or additional meanings in some parts of the country. For
more precise definitions, it is wise to seek the advice of trained
legal counsel.
Accommodator: Same as intermediary, or facilitator. The party
who facilitates the tax-deferred exchange by acquiring and selling
property in an exchange to aid the taxpayer in complying with
Section 1031 and related applicable rules.
Adjusted Basis: The cost of the property adjusted for capital
improvements and depreciation. Begin with the purchase price (cost
basis) of the property, add the cost of any capital improvements
made during ownership, and subtract depreciation taken during
ownership.
Back Leg Reverse Exchange: The Exchange Accommodation
Titleholder (EAT) acquires and holds title to the replacement
property, until such time as the taxpayer can find a buyer for the
relinquished property. Title cannot be "parked" for more than 180
days.
Boot: All property given or received in an exchange that is
not like kind. In an exchange of real property, and consideration
received other than real property is considered non-like kind and is
considered boot.
Cash Boot: Cash or other non-like kind property received in
an exchange.
Mortgage Boot: Any liability in the exchange assumed or taken
subject to.
Build-to-Suit (construction) Exchange: Allows improvements to
be made on a replacement property before it is transferred to the
taxpayer.
Delayed Exchange: From the date of disposition of the
relinquished property, the taxpayer has up to 180 days (or the due
date of his tax return, including extensions, whichever occurs
first) to acquire replacement property. It must be an exchange of
property, as opposed to a sale of property for money that is
ultimately used to purchase property. An exchange occurs when the
taxpayer, through the use of a Qualified Intermediary, conveys
relinquished property to the same party from whom he acquires
replacement property.
Depreciation Recapture: Deductions taken during ownership of
the asset must be "recaptured", or paid back at the recapture tax
rate (currently 25%) rather than the capital gains tax rate.
Exchanger: Same as taxpayer.
Front Leg Reverse Exchange: The Exchange Accommodation
Titleholder (EAT) acquires and holds title to the taxpayer's
relinquished property, allowing the taxpayer to acquire replacement
property directly from the third-party seller. Title cannot be
"parked" for more than 180 days.
Gain: The amount obtained for a property (selling price)
minus the adjusted basis and transaction costs.
Like-kind Property: Property disposed of and property
acquired must be of "like kind" to satisfy Section 1031. There are
two kinds of property - real property and personal property.
Generally speaking, all real property is like kind to all other real
property. For example, an apartment building may be exchanged for
single-family rental housing. Personal property, however, is only
like kind if it is of the same use or quality. So, an airplane may
be exchanged for an airplane, and a boat may be exchanged for a
boat. But an airplane may not be exchanged for a boat.
Qualified Intermediary: See "accommodator", above. Sometimes
called the "QI".
Relinquished Property: The property that the taxpayer
disposes of in the exchange.
Replacement Property: The property that the taxpayer acquires
in the exchange.
Reverse Build-to-Suit Exchange: This type of exchange allows
the taxpayer to acquire and improve or repair the replacement
property before he disposes of his relinquished property. While it
is often complex, and almost always expensive, it can be a very
useful planning tool for the sophisticated investor.
Reverse Exchange: An exchange where the taxpayer acquires
replacement property prior to disposing of the relinquished
property. One of the properties must be "parked" with an Exchange
Accommodation Titleholder, typically an entity under the control of
the Qualified Intermediary. This method was sanctioned by IRS
Revenue Procedure 2002-22
*Source:
LandAmerica 1031 Exchange Services -
http://www.landam.com
LandAmerica Financial Group, Inc. is a leading provider of real
estate transaction services with over 1,000 offices and a network of
more than 10,000 active agents. LandAmerica serves residential and
commercial customers throughout the United States, Mexico, Canada,
the Caribbean, Latin America, Europe, and Asia. A Fortune 500
company, LandAmerica is recognized on Fortune magazine's 2006 list
of America's most admired companies.
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