Under Section 1031 of the Internal
Revenue Code, owners of real estate held
for investment or use in a trade or
business can swap their property
tax-free for "like-kind" real estate.
Exchanges are made for people wanting to
stay invested in real estate, increase
their leverage and to avoid paying hefty
taxes upon the sale of property.
Like
Kind
- Apartments
- Rental Houses
- Retail Properties
- Commercial
- Raw Land
- Office Buildings
- Industrial
- Ranches
Non Qualifying Properties
- Personal Residences
- Dealer Property
- Partnership Interests
- Inventory
Reason to Exchanges
- Restoring Depreciation that will
soon expire - by exchanging one property
for another of greater value.
- To upgrade size and/or quality of
investment. An exchange can be utilized
to combine the equity of one or more
properties into a larger singular
investment.
- To change investment location. An
exchange can be executed in anticipation
of markettrends to maximize appreciation
potential.
7 Steps for a Successful 1031 Tax
Deferred Exchange
Step 1: Consult with your tax and
financial advisors to determine if a tax
deferred exchange is appropriate for
your circumstances and compatible with
your investment goals.
Step 2: Listing the Relinquished
Property for sale with a licensed real
estate broker. During the first step the
Exchanger will list the Relinquished
Property with a real estate broker. The
broker/agent will disclose the intent to
complete an exchange in the listing
agreement.
Step 3: Offer, Counter Offer and
Acceptance. The Exchanger enters into a
contract with the Buyer for the
sale/exchange of the Relinquished
Property. The broker/agent discloses the
Seller/Exchanger's intent to exchange
into the Purchase Agreement and Receipt
for Deposit.
Step 4: Open escrow for the
Relinquished Property and coordinate
with the Facilitator. The Facilitator
prepares the exchange agreement and
coordinates with the escrow holder to
close escrow as Phase I of a tax
deferred exchange. Important: The
exchange agreement must be in place and
signed by all parties prior to close of
escrow. Additionally, all earnest money
deposits should be placed with the title
company.
Step 5: Replacement Property
Identification. After closing escrow for
the sale of the Relinquished Property,
the Exchanger must identify all
Replacement Property within 45 days from
day after close of escrow.
Step 6: Contracting for the
Replacement Property. After closing on
the Relinquished Property the Exchanger
has 180 days to acquire the Replacement
Property. With the help of his or her
agent the Exchanger enters into contract
to purchase the Replacement Property
from the Seller. In the contract to
purchase the agent discloses the
Exchanger's intent to complete the
exchange and obtains the Seller's
cooperation.
Step 7: Open escrow for the
Replacement Property. The Facilitator
prepares the Phase II Exchange Agreement
and coordinates with the Replacement
Property Escrow holder. The funds held
in trust by the Facilitator are placed
in escrow and the Replacement Property
is purchased by the Facilitator from the
seller. The Facilitator then transfers
the Replacement Property to the
Exchanger and the transaction is closed
as Phase II of a delayed exchange.
Identification of Replacement
Property
Regardless of the number of
relinquished properties transferred by
the Exchanger as part of the same
exchange, the maximum number of
replacement properties that the
Exchanger can identify is as follows:
3 Property Rule: Three properties
without regard to the fair market values
of the replacement properties.
Or
200 Percent Rule: Any number of
properties as long as their aggregate
fair market value as of the end of the
identification period does not exceed
200 percent of the aggregate fair market
value of all the relinquished properties
as of the date the relinquished
properties were transferred by the
Exchanger.
Exception
95 Percent Rule: Any number of
replacement properties identified before
the end of the identification period and
received before the end of the exchange
period, but only if the Exchanger
receives before the end of the exchange
period identified replacement property
the fair market value of which is at
least 95 percent of the aggregate fair
market value of all identified
replacement properties.
Glossary of Terms
Accommodator: A principal involved in
the exchange transaction who agrees to
assist the exchanger to effect a
tax-deferred exchange. Same as
Facilitator or intermediary.
Accommodating Party: In an exchange
of properties there is always a person
or entity that steps in to accommodate
or facilitate the exchange transaction.
Depending on how the transaction is
structured, the accommodating party may
incur additional liability in their
efforts to assist in the exchange.
Acquisition Property: Replacement
property
Actual Receipt: When the Exchanger
actually receives the funds from the
sale of the Relinquished Property.
Receipt of cash by the Exchanger before
he receives the Replacement Property may
be enough to destroy the tax deferred
treatment of the transaction.
Adjusted Basis: Generally speaking
the adjusted basis is equal to the
purchase price plus capital improvements
less depreciation. Transactions
involving exchanges, gifts, probates and
receiving property from a trust can have
an impact on calculating the property's
adjusted basis. The taxpayer's C.P.A. or
tax advisor is the party to look to for
these types of questions.
Boot: Boot is any type of property
received or given up in an exchange that
does not meet the like kind requirement.
Generally speaking, receiving boot will
trigger the recognition of gain and
taxes. If the Exchanger receives boot,
they will be taxed. Boot added or given
up by the Exchanger does not necessarily
trigger a taxable event. In a real
property exchange, boot received is any
type of property received by the
exchange which is not real property held
for investment or productive use in a
trade or business.
Cash Boot: Cash Boot consists of cash
and nonqualifying property. A car, a
boat or receipt of the beneficial
interest in a promissory note are all
examples of Cash Boot.
Mortgage Boot: Mortgage Boot consists
of the secured debt given up and
received as part of the same exchange.
If the exchanger increases the amount of
debt on the Replacement Property verses
the Relinquished Property, they have
given mortgage boot. If the exchanger
decreases the amount of debt on the
Replacement Property verses the
Relinquished Property, they have
received mortgage boot. Generally
speaking, mortgage boot received
triggers the recognition of gain and it
is taxable, unless offset by Cash Boot
added or given up in the exchange.
Constructive Receipt: Even if the
Exchanger does not actually receive the
proceeds from the disposition of the
Relinquished Property, the exchange will
be disallowed if the Exchanger is
treated as having constructively
received the funds.
Delayed Exchange: Also called
non-simultaneous, deferred and Starker.
A delayed exchange is a tax deferred
exchange where the Replacement Property
is Received after the transfer of the
Relinquished Property. In a delayed
exchange the Exchanger must identify all
potential Replacement Properties within
45 days from the transfer of the
Relinquished Property and the Exchanger
must Receive all Replacement Properties
within 180 days or the due date of the
Exchanger's tax return whichever occurs
first.
Like-Kind Property: Refers to the
nature of the property the Exchanger
gives up or receives as part of the same
tax deferred exchange transaction. In
order to qualify as like kind the
property given up or received must be
held for productive use in a trade or
business or held for investment to
qualify as like-kind.
Realized Gain: Refers to a gain that
is not necessarily taxed. In a
successful exchange the gain is realized
but not recognized and therefore not
taxed.
Recognized Gain: Refers to gain which
is subject to tax. When someone disposes
of property at a gain or profit in a
taxable transfer such as a sale, the
gain is not only realized, but
recognized and subject to tax.
Relinquished Property: The property
given up by the exchange to start the
1031 exchange transaction. This property
usually passes through an accommodator
before transferring to the ultimate
Buyer.
Reverse Exchange: An exchange where
the Exchange acquires or gains control
of the Replacement Property before
disposing of the Relinquished Property.
Simultaneous Exchange: Also referred
to as a concurrent exchange. A
simultaneous exchange is an exchange
transaction where the Exchanger
transfers out of the Relinquished
Property and Receives the Replacement
Property at the same time.
Transfer Tax: A tax usually assessed
by a city or county on the transfer of
property. It may be based on equity or
value. When structuring a multi-party
exchange an exchange agreement will
usually call for direct deeding to
eliminate additional transfer tax.
April 15th
A taxpayer must identify replacement
property within 45 days after the
transfer of the relinquished property,
and acquire the replacement property
within the earlier of 180 days of the
relinquished property closing, or the
due date of the taxpayer's tax return.
This means that 1031 escrows that close
after Oct. 18 will not have the full 180
days to acquire the replacement property
unless the taxpayer files an extension.
Contact your CPA or tax attorney for
advise.
By Neda Dabestani-Ryba
Prudential Carruthers REALTORS
Neda Dabestani-Ryba is a licensed
Realtor in Maryland. She is a member of
the President's Circle of Top Real
Estate Professionals. She can be reached
at (800) 536-3806 or visit her website
for more information:
http://neda.dabestani.pcragent.com/
Prudential Carruthers REALTORS is an
independently owned and operated member
of Prudential Real Estate Affiliates,
Inc., a Prudential Financial company.
Equal Housing Opportunity
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