What
is a 1031 Exchange?
A
1031 tax deferred property exchange is an exchange in which capital
gains tax deferral is available to real estate owners who sell their
investment, rental, business or vacation real estate, and reinvest the
net proceeds in other real estate. Real Estate held for these purposes
are called like-kind/1031 properties.
Property owners may sell like-kind properties and defer taxes on the
sale's profits by meeting the requirements of Internal Revenue Code
(IRC) 1031 exchange. The purpose of the 1031 Exchange is to allow sellers
of like-kind property to buy replacement property of like-kind within
a specific time period and defer taxes.
Sellers have a maximum of 180 calendar days from the closing of the
initial sale to complete the exchange. Within the first 45 days of this
period a seller must designate candidate properties and properly identify
them to the IRS. A seller may target up to three properties regardless
of value or a group of properties with a combined value that does not
exceed 200 percent of the value of the initial property sale. The funds
in a trust account can be used as earnest money for designated property
once all IRS requirements for a 1031 transaction are met.
If no new properties are identified in the first 45 days or no designated
transaction is completed during the full 180 day period, the trust will
be liquidated and the sale proceeds will be taxed at the prevailing
capital gains rate.
Who
should consider a 1031 Exchange?
If you have
real property that will net you a gain upon sale (generally property
that has been substantially depreciated for tax purposes and/or has
appreciated in value), then you are exactly the person who should consider
a 1031 Exchange.
If you have
a property that will net you a loss upon sale, then you are probably
not someone who should consider a 1031 Exchange unless you do not have
enough capital gains to offset the capital losses you will incur from
the sale of your loss property.
1031
Exchange Rules
- The
real property you sell and the real property you buy must both be
held for productive use in a trade or business or for investment purposes
and must be like-kind.
- The
proceeds from the sale must go through the hands of a qualified intermediary
and not through your hands or the hands of one of your agents or else
all the proceeds will become taxable.
- All
the cash proceeds from the original sale must be reinvested in the
replacement property - any cash proceeds that you retain will be taxable.
- The
replacement property must be subject to an equal level or greater
level of debt than the relinquished property or the buyer will either
have to pay taxes on the amount of decrease or have to put in additional
cash funds to offset the lower level of debt in the replacement property.
1031
Time Lines
- Identification
Period: Within 45 days of selling the relinquished property you must
identify suitable replacement properties. This 45 day rule is very
strict and is not extended should the 45th day fall on a Saturday,
Sunday, or legal holiday.
- Exchange
Period: The replacement property must be received by the taxpayer
within the "exchange period", which ends within the earlier
of . . . 180 days after the date on which the taxpayer transfers the
property relinquished, or . . . the due date for the taxpayer tax
return for the taxable year in which the transfer of the relinquished
property occurs. This 180-day rule is very strict and is not extended
if the 180th day should happen to fall on a Saturday, Sunday or legal
holiday.
Replacement
Property Identification
- 3-property
rule: You may identify any three properties as possible replacements
for your relinquished property. More than 95% of exchanges use the
3-property rule.
- 200%
rule: You may identify any amount of properties as possible replacements
for your relinquished property as long as the aggregate value of those
properties does not exceed 200% of the value of your relinquished
property.
- 95%
exemption: You may identify any amount of properties as possible replacements
for your relinquished property as long as you end up purchasing at
least 95% of the aggregate value of all properties identified.
Like-Kind
Property
In a 1031
real property exchange you can exchange any real property for any other
real property within the United States or its possessions IF said property(ies)
are held for productive use in trade or business or for investment purposes.
Examples
of "Like-Kind Property"
- Apartments
- Commercial
- Condos
- Duplexes
- Raw
Land
- Rental
Homes*
* Qualification
for Section 1031 exchanges depends upon the extent of personal use.
Disclaimer:
The above brief description is not to be construed as legal or tax advice.
Always be sure that you have proper documentation of all the actions
you take in pursuance of your tax strategy. Consult your tax and legal
advisors for more information.
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