1031 Exchange


WHAT IS I.R.C. SECTION 1031?

Section 1031 of the Internal Revenue Code allows an owner of investment property to exchange property and defer paying federal and state capital gains taxes (20% federal, varying state, and 25% depreciation recapture), if they purchase a “like kind” property following the rules and regulations of the Internal Revenue Code. This allows investors to use all of the sale proceeds to leverage into more valuable real estate, increase cash flow, diversify into other properties, reduce management or consolidate holdings.

BENEFITS OF A 1031 EXCHANGE

Single to multiple properties:

•  Tax deferral
•  Increased income stream
•  More tenants yields greater consistency of income stream.
•  Can Diversify property types and locations.
•  Flexibility in selling individually and paying gains taxes slowly.
The real power of a tax deferred exchange is not just the tax savings, it is also the increase in purchasing power generated by the tax savings.

WHAT IS “LIKE KIND” PROPERTY?

•  Duplex
•  Apartment
•  Commercial Property
•  Raw Land

DOES AN EXCHANGE NEED TO BE SIMULTANEOUS?
A 1031 Tax Deferred Exchange is rarely a two party swap. Most exchanges are delayed exchanges, whereby the Exchanger has 180 days between the sale of the Relinquished Property and the closing of the Replacement Property. They must identify the potential Replacement Property within 45 calendar days from closing on the Relinquished Property.

It is important that the Purchase and Sale Agreements for both properties are assignable, and that the Qualified Intermediary/Accommodator is identified as the seller of the Relinquished Property and as the buyer of the replacement property.

WHAT IS A PARTIAL EXCHANGE?
The investor decides to defer some capital gains taxes and to also recognize some gain by accepting 1)cash proceeds, 2) a reduction of debt on the replacement property, or 3) receipt of any property that is not considered “like kind” such as promissory note*, or other personal property, all known as “boot.”
This results in some of the gain being recognized and taxable.
If the boot is greater than the amount of the capital gain, then an exchange is not recommended.
*There are ways for Notes to be received and not become boot, for example, if they are exchanged from the Relinquished Property to the Replacement Property as part of the purchase price.

TIMELINES AND PROPERTY I.D. RULES

In an exchange the timeline for completion of exchange begins on the date of closing of the relinquished property. If there are more than one property being relinquished, the first closing establishes the beginning date. It is very smart, if not necessary, to have the Relinquished Property sale escrow set up with a contingency for finding new property, and to have alternate resolutions.
Within 45 days from the closing of the first Relinquished Property, the Qualified Intermediary must receive a signed Identification of the Replacement Property(ies), unambiguously identified by specific address, APN, or legal description.
200% Rule. The exchanger may identify any number of replacement properties as long as their total value is not greater than 2 X the value of the relinquished property. Value is the purchase price, can be difficult to determine market value, therefore be careful using comps.
3 Property Rule. The exchanger may identify up to 3 property of any total Fair Market Value.
95% Rule. If the taxpayer identifies properties in excess of both the 200% and the 3 Property Rules, he must acquire 95% of the value of all properties identified.
Basis carries over from the original not the last sale. Will be divided proportionately into all the upleg properties. Depreciation schedules also carry forward to the new property(ies).
Sale Agreement and Purchase Agreement must be assignable. Use CAR form Intent to Exchange.
From: Asset Preservation Inc.