1031 Tax Deferred Exchanges
THE POWER TO PROTECT, GROW, AND DIVERSIFY
Thanks to the IRC S1031, a properly structured exchange allows an investor to sell an investment property, and acquire a new property, and potentially defer all capital gain taxes. IRC S1031 (a) (1) states:
No gain or loss shall be recognized on the exchange of property
held for productive use in a trade or business or for investment
if such property is exchanged solely for property of like-kind which
is to be held for investment.
THE POWER OF FLEXIBILITY
Pursuant to IRC S1031, capital gain deferment requires the exchange of "like-kind" relinquished property for other "like-kind" replacement property. Generally real property held for investment or real property used in a trade or business can be exchanged for other real property held for investment or real property used in a trade or business.
THE EXCHANGE EQUATION: 100% TAX DEFERRAL
To fully defer all capital gain taxes, an Exchanger must meet two requirements:
- Reinvest all exchange proceeds to acquire like-kind property.
- Acquire like-kind property of equal or greater value
WHAT'S THE FIRST STEP
Always discuss a $1031 tax deferred exchange with your tax advisors. There are tax exchange specialists who will act as an intermediary. They sometimes give free consultations; do this before you are ready to close on the relinquished property. There are stipulations which must be met in order for the exchange to be valid.
Include language stating the intent to perform a $1031 tax deferred exchange in the Purchase and Sales Agreement:
"Buyer is aware that Seller intends to perform an IRC S1031 tax
deferred exchange. Seller requests Buyer's cooperation in such
an exchange and agrees to hold Buyer harmless from any and all
claims, liabilities, costs or delays in time resulting from such an
exchange. Buyer agrees to an assignment of this contract to
(put name of your Qualified Intermediary here), by the Seller."
EXCHANGE: POWERFUL STRATEGIES
- THE DELAYED EXCHANGE: A delayed exchange is the most common exchange format. It provides investors up to 180 days to acquire replacement property through the use of a Qualified Intermediary to complete a valid delayed exchange.
- THE IMPROVEMENT EXCHANGE: Improvement (build-to-suit or construction) exchanges proceeds to either (1) make improvements to a new replacement property or (2) build a new replacement property.
- THE REVERSE EXCHANGE: A reverse exchange is the purchase of replacement property prior to closing on the relinquished property structured through the use of an exchange accommodation titleholder.
- THE PERSONAL PROPERTY EXCHANGE: Exchanges of personal property, such as aircraft or business equipment for business equipment can qualify for tax deferral.
SALE OF THE RELINQUISHED PROPERTY
Prior to closing the sale of the relinquished property, the Exchanger enters into the Exchange Agreement with a facilitator. Pursuant to the Exchange Agreement, an Assignment is executed prior to closing, and Exchanger assigns its rights under the Purchase and Sale Agreement to the facilitator. The facilitator instructs the closing/escrow officer or closing attorney to directly deed the property from the Exchanger to the buyer. Proceeds are transferred directly to the Qualified Intermediary, thereby protecting the Exchanger from actual or constructive receipts of funds. Please note that @1031 Regulations mandate restrictions on the Exchanger's ability to access exchange proceeds at any time. Please consult with your facilitator for more details on these restrictions.
IDENTIFICATION OF REPLACEMENT PROPERTY
The Exchanger must properly identify potential replacement properties with 45 calendar days. The facilitator provides the Exchanger with the specific identification requirements.
PURCHASE OF THE REPLACEMENT PROPERTY
The Exchanger has a total of 180 calendar days from closing of the relinquished property, or their tax filing date (including extensions), whichever is earlier, to acquire "like-kind" replacement properties. Prior to closing on the replacement property. the Exchanger assigns the Purchase and Sale Agreement to the Qualified Intermediary. After the Assignment is executed, the exchange is completed when the Qualified Intermediary purchases the replacement property with the exchange proceeds and transfers it back to the Exchanger by a direct deed from the seller.