| Property owners can defer capital gains taxes on | | | | exchange value. |
| the equity in their property by using Internal | | | | 3. In a Delayed Exchange, there is a time gap |
| Revenue Code Section 1031. Known commonly as | | | | between the transfer of the relinquished property |
| a "1031 exchange option," this application of the | | | | and the acquisition of the replacement property. |
| tax code is one of few provisions available to | | | | The IRS has very strict time limits on delayed |
| postpone or potentially eliminate taxes due from | | | | exchanges and you must comply with the |
| the sale of qualifying properties. | | | | requirements. This type of exchange is facilitated |
| As a property owner, you may also achieve a | | | | through the use of a third party, called a "qualified |
| wide range of investment objectives by using a | | | | intermediary." The intermediary holds the |
| 1031 exchange. You can diversify your real estate | | | | proceeds from the initial exchange until the |
| investment portfolio, consolidate your real estate | | | | replacement property, which meets the like-kind |
| holdings in a single larger property, and possibly | | | | specifications, is identified and purchased. |
| improve your cash flow from your real estate | | | | A qualified intermediary is an essential member of |
| investments. | | | | your team when working on a successful |
| What qualifies as a Section 1031 Exchange? | | | | exchange. An intermediary cannot be the |
| Section 1031 states that no gain or loss shall be | | | | property owner or any "disqualified person" (which |
| recognized on the exchange of any real property | | | | is defined as those people who have represented |
| when the property owner trades one or more | | | | or served you in their professional capacities |
| properties for a replacement property or | | | | within the previous two years). A disqualified |
| properties that are of "like-kind." Like-kind means | | | | person would include your accountant, attorney, |
| any real estate, improved or unimproved, that the | | | | or real estate agent. |
| owner uses for income, investment, or business. | | | | Under the IRS code, there are no formal licensing |
| That means you can exchange one property for | | | | requirements for qualified intermediaries. But they |
| two or more properties, or trade two or more | | | | may need to be licensed as an escrow firm by |
| properties for one replacement property. You can | | | | the state in which they practice. |
| trade land or several single-family homes for an | | | | The rules for the exchange |
| apartment building. Investment property can be | | | | The Internal Revenue Code outlines in great detail |
| exchanged for business property and vice versa. | | | | the time restrictions on completing a Section 1031 |
| One stipulation is that the property to be | | | | Exchange. You have 45 days after the date the |
| exchanged and the like-kind replacement property | | | | relinquished property is transferred to properly |
| must both be located in the United States. Also, | | | | identify potential replacement properties. The |
| under the rules of IRS Section 1031, you cannot | | | | exchange must be completed within 180 days |
| exchange your personal residence for income | | | | after the transfer of the relinquished property or |
| property, and you cannot exchange income or | | | | before your federal tax return due date for the |
| investment property for a personal residence. | | | | year in which you transfer your relinquished |
| The rules of tax deferral | | | | property, whichever is earlier. |
| In a Section 1031 Exchange, the tax on the equity | | | | If you fail to meet the Section 1031 time limits, |
| in the property - the value of the property over | | | | the tax-deferred exchange will fail, and you will |
| the original purchase price - is deferred. The | | | | have to pay any taxes arising from the sale of |
| property you relinquish must be exchanged for | | | | the relinquished property. The IRS may grant an |
| other property; you can't sell the property for | | | | extension in only one instance: if the transaction |
| cash then use the cash to purchase replacement | | | | closing is delayed by a U.S. government federally |
| property. | | | | designated disaster, such as a hurricane or |
| In a "like-kind" exchange, tax is deferred, not | | | | earthquake. |
| eliminated. You reinvest what would be the sales | | | | Section 1031 Exchanges have three specific and |
| proceeds into another property; therefore, your | | | | inflexible rules that limit the number of properties |
| gain isn't realized in a way that generates funds to | | | | you can identify for exchanges. You must meet |
| pay any tax. | | | | the requirements of at least one of these three |
| The four basic rules for a property owner to | | | | rules: |
| qualify for a tax deferral on all the taxable gains | | | | 1. The three-property rule: You may identify up to |
| under the 1031 rules are: | | | | three potential replacement properties, without |
| 1. The equity in the replacement property must | | | | regard to value. |
| be equal to or greater than the equity in the | | | | 2. The 200 percent of value rule: You may |
| relinquished property. | | | | identify any number of properties, but their total |
| 2. The value of the replacement property must | | | | value cannot exceed twice the value of the |
| be equal to or greater than the value of the | | | | relinquished property. |
| relinquished property. | | | | 3. The 95 percent of fair market value rule: You |
| 3. The debt on the replacement property must | | | | may identify as many replacement properties as |
| be equal to or greater than the debt on the | | | | you want, but before the end of the exchange |
| relinquished property. | | | | period, you must acquire properties with total fair |
| 4. All of the net proceeds from the sale of the | | | | market value equal to at least 95 percent of the |
| relinquished property must be used to acquire the | | | | aggregate fair market value of all the identified |
| replacement property. | | | | properties. In other words, if you identify 20 |
| The 3 types of 1031 Exchanges | | | | properties at $1 million each for a total value of |
| The Section 1031 Exchange type depends largely | | | | $20 million, you must acquire 19 of those |
| on the time involved. For example: | | | | properties at $19 million, to satisfy the 95 percent |
| 1. In a Simultaneous Exchange, you would | | | | requirement. |
| exchange your relinquished property for your | | | | ALWAYS FIRST CONSULT A HIGHLY |
| replacement property at the same time, closing | | | | QUALIFIED REAL ESTATE TAX PROFESSIONAL!!! |
| both transactions simultaneously. | | | | As the taxpayer, you must comply with the rules, |
| 2. In an Improvement Exchange, you are allowed | | | | conditions, and timeframes in the IRS Code, as |
| to make improvements to a replacement | | | | provided in Section 1031. It is highly recommended |
| property before the exchange is made. This type | | | | that you consult a competent tax attorney, a |
| of exchange is facilitated through a third party, | | | | certified public accountant, a "qualified |
| called an Exchange Accommodation Titleholder | | | | intermediary," or a well-qualified tax advisor who |
| (EAT). The EAT holds title to the new property | | | | specializes in real estate to determine how a 1031 |
| while the improvements are being completed. | | | | exchange should be structured to accomplish your |
| Once you take title, you cannot include money | | | | investment objectives with minimum taxation. |
| spent on any more improvements as part of the | | | | |