Become familiar with the 1031 Exchange Experience
DEFER YOUR CAPITAL GAINS ( SECTION 1031 )
Section 1031 of the IRS ( Internal Revenue Service) Code provides an effective strategy for deferring the capital gains tax that may arise from your business/investment
property sale. Through an exchange of the property for like-kind real estate, property owners may defer their tax and use all of the proceeds for the purchase of a replacement property. Like kind real estate may include business/investment property, but not the property owners personal residence. The 1031 exchange process does not apply to the exchange of stocks or bonds.
Those building wealth through real estate know that the 1031 Tax Deferred Exchange can be a primary tool in the wealth building process. A primary reason for this is the deferment of taxable gain from the sale of a property.
There are specific timelines and procedures that must be followed for a successful 1031 exchange
Here are some Guidelines to remember:
- Seller should specify in the sales contract that the sale maybe structured as a 1031 exchange
- Seller cannot receive or have any contact with any of the proceeds of the sale – the proceeds
- Must be deposited with a qualified intermediary in escrow account.
- The replacement property must be identified within 45 days from the sale of the original property
- Replacement property must be acquired within 180 days from the sale of the original property
- If a reverse exchange, the taxpayer acquires the replacement property prior to disposing of the relinquished property
- Cash, invested in the replacement property must be equal to or greater than the cash received from the sale of the relinquished property
- Debt placed or assumed on the replacement property must be equal to or greater than the debt relieved in the relinquished property.
WHAT IS A 1031 EXCHANGE ?
A 1031 Exchange is a transaction in which a taxpayer is allowed to sell one property and buy another without a tax consequence. This can be done through a simultaneous or delayed 1031 Exchange.
The transaction is authorized by the 1031 IRS Code. It may be the best strategy for the deferral of capital gains tax that would ordinarily arise from the sale of real estate. This may not be the best strategy for real estate investors who are selling properties for liquidity purposes.
A successful exchange results in the taxpayer being able to utilize 100% of the proceeds from the sale of the property to purchase a new property thereby deferring the capital gains taxes.
Real Estate owners may accomplish a variety of investment objectives with 1031 Exchanges including, greater leverage, diversification, potentially improved cash flow, geographic relocation and/or property consolidation.
HOW DOES IT WORK ?
A 1031 Exchange is usually a delayed exchange, in which an intermediary is used to facilitate the transaction. There are four basic steps.
- Seller contracts for the sale of property and includes exchange language in the contract
- At closing, sales proceeds go to a 3rd party (Qualified Intermediary should be enlisted to hold the funds, and handle the transaction ) for an exchange. The seller at no time shall take possession of the funds.
- Seller must identify an exchange property(ies) within 45 days after the closing of the initial property. ( may identify no more than 3 properties )
- Seller must complete 1031 Exchange within 180 days of the initial property closing. ( must close on one or more of the properties named within this 180 day time period)
MAJOR DIFFICULTIES IN COMMPLETING A 1031 EXCHANGE ARE:
- Only 45 days to find and identify a replacement property
- Doing due diligence and analyzing the financing structure on a potentialreplacement property
- Closing on the property within 180 days
Terms and Definitions in a 1031 Exchange:
‘Like-Kind Property’: Like-kind property refers to the type of property being exchanged. You can exchange any real estate investment for any other type of real estate investment. As an example, vacant land can be exchanged for rental property. Your personal residence does not qualify for a Like-Kind Exchange or investment property.(if the personal residence is used as the current residence )
‘Exchanging up’: To have a successful fully tax-deferred exchange the rule is to Exchange Even or Up in Value and Exchange Even or Up in Equity and in debt.
‘Boot’ :In the event that the exchange is not even or up in Value and/or exchange even or up in Equity or debt, you will have received non-qualifying property (“boot”) in your exchange. If Boot is received, tax is computed on the amount of gain on the sale or the amount of boot received – whichever is lower.
DO ADVANCE PLANNING FOR AN EXCHANGE. Talk to your accountant, broker, financial planner, lender and Qualified Intermediary.
DO NOT MISS YOUR IDENTIFICATION AND EXCHANGE DEADLINES
DO NOT TRY DOING A 1031 EXCHANGE YOURSELF or your attorney or COA to hold funds. IRS rules require a Qualified Intermediary.
DO NOT DISSOLVE Partnerships or Change the manner of holding title during the Exchange.
DST properties are available to accredited investors only (generally described as having a net worth of over $1 million dollars exclusive of primary residence) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney prior to considering a 1031 exchange/sale of your property. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.
There are risks associated with investing in real estate and Delaware Statutory Trust (DST) properties including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity.
Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. This material is not to be interpreted as tax or legal advice.