1031 Exchange – Considering A Tax Deferred “1031 Exchange”?
How I can help on a State-wide basis:
- Connect you with reputable, Qualified Intermediaries.
- Assist you in finding replacement properties, including TICs.
- Educate you on how oil and gas properties can qualify.
- Help you locate a professional 1031 Attorney or Accountant.
- Supply the financing on your replacement property.
1031 exchange, otherwise known as a tax-deferred exchange, is an exchange in which the taxpayer or exchanger transfers property that is held for productive use in a trade or business or for investment in return for receipt of other “like-kind” property, which is also to be held for productive use in a trade or business or investment purposes. The logistics and process of selling a property and then buying another property are practically identical to any standardized sale and buying situation, a “1031 exchange” is unique because the entire transaction is treated as an exchange and not just a simple sale. It is this difference between “exchanging” and not simply buying and selling that, in the end, allows the taxpayer(s) to qualify for a deferred gain treatment. So to say it in simple terms, sales are taxable with the IRS, and 1031 exchanges are not. US CODE: Title 26, §1031. Exchange of Property Held for Productive Use or Investment
Because exchanging a property represents an IRS-recognized approach to the deferral of capital gain taxes, you need to understand the components and the actual intent underlying such a tax-deferred transaction. Within Section 1031 of the Internal Revenue Code, we can find the appropriate tax code necessary for a successful exchange. We would like to point out that within the Like-Kind Exchange Regulations, issued by the US Department of the Treasury, we find the specific interpretation of the IRS and the generally accepted standards of practice, rules, and compliance for completing a successful qualifying transaction. Within this website, we will be identifying these IRS rules, guidelines, and requirements of 1031. It is very important to note that the Regulations are not simply the law but a reflection of the IRS’s interpretation (Section 1031).
Why 1031 Exchange?
Any Real Estate property owner or investor of Real Estate should consider an exchange when he/she expects to acquire a replacement “like kind” property after the sale of his or her existing investment property. Anything otherwise would necessitate the payment of a capital gain tax, which can exceed 20-30%, depending on your given state’s federal and state tax rates. To make it easy to understand, when purchasing a replacement property (without the benefit of a 1031 exchange) your buying power is reduced to the point that it only represents 70-80% of what it did previously (before the exchange and payment of taxes). Below is a look at the basic concept, which can apply to all 1031 exchanges. We should understand this concept by selling a relinquished real estate property to defer the realized capital gain taxes completely. The two major rules to follow are:
- The total purchase price of the replacement “like kind” property must be equal to or greater than the total net sales price of the relinquished real estate property.
- All the equity received from the sale of the relinquished real estate property must be used to acquire the replacement, “like-kind” property. The extent that either of these rules (above) are violated will determine the tax liability accrued to the person executing the Exchange. In case the replacement property purchase price is less, there will be a tax responsibility incurred. To the extent that not all equity is moved from the relinquished to the replacement property, there will be tax. This is not to say that the (1031) exchange will not qualify for these reasons. Remember that partial exchanges do, in fact, qualify for partial tax-deferral treatment. This simply means that the amount of the difference (if any) will be taxed as a boot or “non-like-kind” real estate property.
THE 1031 Exchange Rule
A property transaction can only qualify for a deferred tax exchange if it follows the 1031 exchange rule in the US tax code and the treasury regulations.
The foundation of the 1031 exchange rule by the IRS is that the properties involved in the transaction must be “Like Kind,” and Both properties must be held for a productive purpose in business or trade as an investment.
The 1031 exchange rule also lays down a guideline for the proceeds of the sale. The proceeds from the sale must go through the hands of a “qualified intermediary” (QI) and not through your hands or the hands of one of your agents, or else all the proceeds will become taxable. The entire cash or monetary proceeds from the original sale must be reinvested to acquire the new real estate property. Any cash proceeds retained from the sale are taxable.
The second fundamental rule is that the 1031 exchange requires that the replacement property must be subject to an equal or greater level of debt than the property sold, or as a result, the buyer will be forced to pay the tax on the amount of decreased. If not, he/she will have to put in additional cash to offset the low debt amount on the newly acquired property.
1031 Exchange Rules and Timelines:
There are two timelines that anybody going for a 1031 property exchange or (TIC) should abide by and know.
The Identification Period: This is the crucial period during which the party selling a property must identify other replacement properties that he proposes or wishes to buy. It is not uncommon to select more than one property. This period is scheduled as exactly 45 days from the day of selling the relinquished property. This 45 days timeline must be followed under any circumstances and is not extendable in any way, even if the 45th day falls on a Saturday, Sunday, or legal US holiday.
The Exchange Period: This is the period within which a person who has sold the relinquished property must receive the replacement property. It is referred to as the Exchange Period under the 1031 exchange (IRS) rule. This period ends precisely 180 days after the date on which the person transfers the property relinquished or the due date for the person’s tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever situation is earlier. According to the 1031 exchange (IRS) rule, the 180-day timeline has to be adhered to under all circumstances. It is not extendable in any situation, even if the 180th day falls on a Saturday, Sunday, or legal (US) holiday.