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The 1031 Tax Deferred Exchange...
The tax deferred exchange, as
defined in Section 1031 of the Internal Revenue Code of 1986, as amended, offers real
estate investors one of the last great investment opportunities to build wealth and save
taxes. By completing an exchange, the investor (Exchanger) can dispose of their investment
property, use all of the equity to acquire replacement investment property, defer the
capital gain tax that would ordinarily be paid, and leverage all of their equity into the
replacement property. Two requirements must be met to defer the capital gain tax:
(a) The Exchanger must acquire "like
kind" replacement property.
(b) The Exchanger cannot receive cash or
other benefits (unless the Exchanger pays capital gain taxes on this money).
In any exchange the Exchanger must enter
into the exchange transaction prior to the close of the relinquished property. The
Exchanger and the Qualified Intermediary enter into an Exchange Agreement, which
essentially requires:
(a) The Qualified Intermediary acquires the
relinquished property from the Exchanger and transfers it to the buyer by a direct deed
from the Exchanger.
(b) The Qualified Intermediary acquires the
replacement property from the seller and transfers it to the Exchanger by a direct deed
from the seller.
The cash or other proceeds from the
relinquished property are assigned to the Qualified Intermediary and are held by the
Qualified Intermediary in a separate, secure account. The exchange funds are used by the
Qualified Intermediary to purchase the replacement property for the Exchanger.
Important Considerations for an Exchange
 | Exchanges must be completed within strict time limits with
absolutely no extensions. The Exchanger has 45 days from the date the relinquished
property closes to "Identify" potential replacement properties. This involves a
written notification to the Qualified Intermediary listing the addresses or legal
descriptions of the potential replacement properties. The purchase of the replacement
property must be completed within 180 days after of the close of the relinquished
property. After the 45 days has passed, the Exchanger may not change their Property
Identification list and must purchase one of the listed replacement properties or the
exchange fails! |
| To avoid the payment of capital gain taxes the Exchanger
should follow three general rules: |
(a) Purchase a replacement property that is
the same or greater value as the relinquished property.
(b) Reinvest all of the exchange equity
into the replacement property.
(c) Obtain the same or greater debt on the
replacement property as on the relinquished property.
The Exchanger can offset the amount of debt
obtained on the replacement property by putting the equivalent amount of additional cash
into the exchange.
| In the case of real property exchanges, the Exchanger must
sell property that is held for income or investment purposes and acquire
replacement property that will be held for income or investment purposes.
This is the "like kind" property test. |
| I.R.C Section 1031 does not apply to exchanges of stock in
trade, inventory, property held for sale, stocks, bonds, notes, securities, evidences of
indebtedness, certificates of trust, or beneficial interests or interests in a
partnership. |
The Exchanger is always advised to discuss the
intended exchange with their legal or tax advisor.
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