1031 Exchange As A Marketing Tool – For Realtors

How Can 1031 Exchange Help You In Generating Business?
The §1031 tax deferred treatment of capital gains is one of the
most attractive real estate investor vehicles for preserving and
building real estate wealth: This provision of the tax code
allows property owners to exchange their property for other
like-kind property without recognition of capital gains
The capital gain and tax liability are both transferred
(“deferred”) from the “old” property into the “new” one, so
there are not tax consequences or liability to the seller at the
time of the sale of the “old” property
The beginning
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The concept of exchanging properties to avoid (“defer”) tax is
not new 1031 exchange reformed variation of Two and Multi-party
exchange
First; Two-party exchange
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Direct exchange (ie, a swap), or the “your property” for “my
property” is called a two-party exchange Here there are two
property owners who each want the other’s property When this
rare situation occurs, the parties exchange properties and avoid
(“defer”) tax liabilities The main problem here is that rarely
there will be two property owners who each want the other’s
property
Then; Multi-party exchange
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The three-way or multi-party exchange technique was designed to
solve the dilemma of a two-way swap The big problem here is
that if one or more of the parties would not cooperate with the
exchange, the entire exchange failed like a “Domino Effect”
Now; 1031 Exchange
——————
By permitting you to “sell” your Relinquished (“old”) Property
now and use the proceeds to buy the Replacement (“new”) Property
later 1031 exchange eliminate the need of finding another real
estate owner who agrees to exchange properties (instead of
selling) to avoid tax liability
Exchange Requirements
———————
Overview
——–
There are three conditions that must be met to accomplish
non-recognition of gain under §1031:
1 The properties exchanged must qualify, and be of “like-kind”
2 There must be an actual exchange, not a transfer of property
for money only
3 The time requirements must be strictly followed Qualify,
“like-kind”
To qualify as a like-kind exchange, the property must be both
(1) qualifying property and (2) like-kind property
What is a qualify property? For income tax purposes, real estate
is divided into four categories made as of the date the
transaction:
1 Held for business use (§1231) – property used in normal
course of business or rental property; Qualify
2 Held for investment (§1221) – property purchased and sold for
generating capital gain; Qualify
3 Held for personal use – vacation home, second home; Does not
Qualify
4 Held primarily for sale (dealer property) – resale or
inventory; Does not Qualify
The first two classifications “held for business” and “held for
investment” qualify for §1031 treatment while the second two
“held for personal use” and “dealer property-do not” What if a
property falls under two categories?
For example what if a property held for investments partially
used for personal use? The sale will be allocated between the
two categories based on the portion of each one
The Exchange Process
——————–
The following is a review of the process and timeline:
Sale of Relinquished (“old”) Property
To trigger the tax deferred transaction, you must sell your
property
Identification the Replacement (“new”) Property
You have 45 days from the day you sell the “old” property to
identify the replacement (“new”)
Replacement Property is identified only if it is designated as
one in a written document signed by you This document must be
hand delivered, mailed, faxed or otherwise sent before the end
of the identification period to a person (other than yourself or
a related party) involved in the exchange The document must
include unambiguous legal description or street address of the
property
Number of Replacement Properties that can be identified You may
identify more than one property as Replacement Property subject
to three rules:
3-Property Rule: The maximum number of replacement properties
you may identify is three properties regardless of their fair
market values
The 200 Percent Rule: There is no limit on the number of
properties you identify as long as their total fair market value
does not exceed 200 percent of the total fair market value of
all Relinquished Properties
The 95 Percent Rule: There is no limit on the number of
properties you identify as long as during the Exchange Period
you actually received identified Replacement Properties having a
fair market value equal to or more than 95 percent of the total
fair market value of all identified Replacement Properties
Value of Replacement (“New”) Property
————————————-
The value of the Replacement Property must be equal to, or
greater than, the adjusted sales price of the Relinquished
Property
All proceeds from the Relinquished Property sale need to be
invested in the Replacement Property
Sale Proceeds Go To Qualified Intermediary
——————————————
Section 1031 requires an actual exchange of properties If you
simply sell your property and reinvest the money in another
property, you will not qualify for exchange treatment, even
though it is a simultaneous close
A Qualified Intermediary is a person (or company) who, for a
fee, acts to facilitate the deferred exchange by entering into
an agreement with you for the exchange of properties The
Qualified Intermediary does not provide legal or specific tax
advice to the exchanger, but will usually perform the following
services:
1 Coordinate with the exchangers and their advisors, to
structure a successful exchange
2 Prepare the documentation for the Relinquished Property and
the Replacement Property
3 Furnish escrow with instructions to effect the exchange
4 Secure the funds in an insured bank account until the
exchange is completed
5 Provide documents to transfer Replacement Property to the
exchanger, and disburse exchange proceeds to escrow Receipt of
Replacement Property
You have 180 days from the day you sell the “old” property to
receive the replacement (“new”)
Replacement property is treated as received before the end of
the exchange period if:
1 You actually acquired the Replacement Property (close the
transaction) prior to the end of the exchange period (180 days,
or the due date of the taxpayers tax return, whichever is
earlier), and
2 The Replacement Property acquired is substantially the same
as identified during the 45- day identification period
Boot and Taxable Gain
———————
Money and unlike property in an exchange is called boot
If, in addition to the Replacement Property, you receive money
or some other kind of boot, you may have taxable gain The tax
is due only on gain that comes from the money and other boot
received
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